The Inflation Reduction Act of 2022 (IRA) is landmark energy and climate legislation intended to revitalize and expand the renewable energy industry with the extension and expansion of many energy tax credits and the introduction of new Bonus Credits, including the Domestic Content Bonus Credit, the Energy Communities Bonus Credit, and the Low-Income Communities Credit.
The Domestic Content Bonus Credit is a powerful tax incentive, but to date it is proving to be one of the most difficult to qualify for and claim. The steel/iron requirement is straightforward, but the manufactured product rule is more complicated, since the rule requires developers to obtain actual material and labor costs from their manufacturers or suppliers, which is a challenging task. Project developers have found that it has been difficult to finance any energy project using the assumption that the Domestic Content Bonus Credit will apply.
Guidance from Treasury and the IRS creates a new elective Safe Harbor rule to address this issue, but
will this alternative approach really help many taxpayers?
- Are there issues remaining that will prevent taxpayers from qualifying with certainty for the Domestic
Content Bonus Credit? - What improvements to the current rules could be made in proposed regulations that would further
simplify the qualification and due diligence process for taxpayers?
The ITC and PTC Enhanced Tax Credit
Investment Tax Credits and Production Tax Credits are available for a wide range of renewable energy projects including Solar, Wind, Energy Storage, and Hydrogen. In order to maximize the amount of the Tax Credits (5 times the base amount), the project must meet the Prevailing Wage and Apprenticeship (PWA) requirements. The Bonus Credits create the potential for total tax credits ranging from 30% to 70%.
An Investment Tax Credit (ITC) is available for investment in renewable energy projects. The base amount of the ITC is 6% which is increased to 30% if the PWA requirements are met or the facility has a maximum net output of less than one megawatt of electrical energy (One Megawatt Exception).
A Production Tax Credit (PTC) is available for electricity produced from qualified energy resources at a qualified facility during the 10-year credit period which is sold to an unrelated party. The base credit amount is 0.55 cents per kilowatt hour or 5 times that amount (2.75 cents) if the PWA requirements are met.
The 10% Domestic Content Bonus Credit
The ITC/PTC is increased by 10% if the project meets certain Domestic Content requirements for steel, iron, and manufactured products. To meet the Domestic Content requirements, the taxpayer must ensure that a certain percentage of components, which are steel, iron, or manufactured products, are manufactured in the United States.
The Adjusted Percentage Rule provides that a certain “adjusted percentage” of the manufactured products and components included in the project must be US-sourced with the adjusted percentage of 40% for most types of projects which begin construction before 2025 (and 20% for offshore wind facilities) and increasing to 55% for projects that begin construction after 2026.
To date, the only guidance that has been issued on the Domestic Content Bonus Credit is in the form of notices, including Notice 2023-38 (May 12, 2023) and Notice 2024-41 (May 24, 2024). No proposed regulations have been released, although in the guidance to date Treasury states that it plans to issue more guidance.
The 2024 IRS guidance permits owners of solar, onshore wind, and battery storage facilities to elect the new elective Safe Harbor rule in lieu of reliance on manufacturer’s direct costs data for purposes of meeting the Adjusted Percentage Rule.
The new elective Safe Harbor at first glance appears to be a useful tool, but in practice, taxpayers are finding it may not help them meet the requirements for every project or facility.
Does the New “Safe Harbor” Simplify the Qualification Process?
Notice 2024-41 provides a new elective Safe Harbor for solar, onshore wind, and battery storage facilities that allows a taxpayer to qualify for the Domestic Content Bonus Credit without the need to obtain cost data from manufacturers and suppliers. To assist taxpayers in determining whether the minimum percentage of the costs of the manufactured products and components of manufactured products is met, the Notice includes Table 1 that assigns cost percentages for each of the manufactured products or components listed in Table 1 for a limited set of project types including PV solar, onshore wind, and battery storage.
Note, however, that taxpayers must still determine which project products and components are included in Table 1, as well as which parts of their projects are US-produced. These data points should be easier for taxpayers to obtain from manufacturers than direct costs, but they are still necessary in order to support the claim for the Domestic Content Bonus Credit. Mixed-source products and components, which are both USand foreign-sourced, are subjected to a weighted average formula.
Two special rules also apply. If the taxpayer’s project includes manufactured products or components that are not included in Table 1, they cannot count toward the adjusted percentage rule. If the taxpayer’s project does not include manufactured products or components that are listed in Table 1, they are ignored for purposes of the adjusted percentage rule.
Solar projects with US-produced cells will benefit from the new elective Safe Harbor, since the assigned percentage for the cells alone ranges from 21.5% to 49.2%. Onshore wind projects with US-produced nacells which account for a 47.5% assigned cost percentage will also benefit.
The new elective Safe Harbor does not solve all issues, however, and further improvements to the current rules could make this process more practical for taxpayers:
- Projects that don’t have US-produced solar cells may not have sufficient components that are USproduced to be able to rely on the Safe Harbor. The Safe Harbor assigns a significant percentage of the overall costs to the solar cells. These projects will be forced to rely on the original framework from Notice 2023-38, which requires more information gathering and diligence.
- Developers who believe that the assigned cost percentages are too low may opt not to rely on the Safe Harbor. Since manufactured products and components that are not listed in the Safe Harbor Table 1 are not included in the cost percentage total, developers may be better off not using the Safe Harbor if they are able to obtain the cost information. Taxpayers should consider modeling to determine if the Safe Harbor provides the best result.
- The Safe Harbor is only available to solar, onshore wind, and battery storage projects, so all other projects cannot use it. Expansion to other types of projects would be helpful, and it is noteworthy that Treasury asked for comments on this issue in Notice 2024-41.
- Expansion of the scope of Table 1 for the Safe Harbor to include component costs for a broader selection of components/manufactured products would be helpful.
What Should You Know about the Domestic Content Bonus Credit and the IRS Guidance?
- Changes to the safe harbor in Notice 2023-38 include revised lists of relevant components of solar, onshore wind, and battery storage facilities, including rooftop solar facilities and associated batteries.
- Taxpayers who elect the new elective Safe Harbor in Notice 2024-41 must use it for the entire project, must apply its categorizations of steel or iron products, and must meet the steel/iron requirement of 100% US-produced. Any steel or iron not included in the listed categories is ignored for purposes of the Safe Harbor. The new elective Safe Harbor, however, can be applied on a projectby-project basis.
- Remember that the PWA rules must be met (or an exception applies) in order to get the full 10% Domestic Content Bonus Credit.
- The taxpayer who relies on the new elective Safe Harbor must attach a statement to that effect in its Domestic Content certification, which is attached to the applicable IRS form for reporting the Domestic Content Bonus Credit amount and filed with the taxpayer’s return for the first taxable year reporting the bonus credit amount for the project. The IRS has not yet created a specific form for the Domestic Content certification, but Notice 2023-38 sets forth the information that should be included.
- Technology-neutral tax credits (“Clean Electricity” tax credits) replace both the ITC and the PTC for projects that begin construction and are placed-in-service after 2024. Projects that “begin construction” before January 1, 2025, and are placed-in-service in 2025 are eligible to qualify for either the current law ITC/PTC or the new Clean Electricity tax credits, and they are also eligible for the Domestic Content Bonus Credit. To meet the “begin construction” rule, taxpayers must either “start physical work of a significant nature” or “incur at least 5% of the total cost of the facility by the end of 2024,” and in either case, meet the “continuous construction” test (with a 4-year safe harbor rule allowed).
- For Direct Payment projects, there are special rules for projects beginning construction after December 31, 2024, including a requirement that the Domestic Content rules must be met or the amount of the Bonus Credit available is decreased to 85% for projects that begin construction in 2025 and no credit for projects that begin construction in 2026.
- Projects that are able to rely on the new elective Safe Harbor will likely be more attractive to the market for financing energy projects since there will be more certainty about qualification for the Domestic Content Bonus Credit.
Assistance is Available at the Potomac Law Renewable Energy Practice
If you need assistance on issues related to the Domestic Content Bonus Credit, or other Energy Tax Credit issues, please contact Susan Rogers at srogers@potomaclaw.com.
Note: This publication is distributed with the understanding that the author, publisher and distributor of this publication and/or any linked publication are not rendering legal, accounting, or other professional advice or opinions on specific facts or matters and, accordingly, assume no liability whatsoever in connection with its use. Pursuant to applicable rules of professional conduct, portions of this publication may constitute Attorney Advertising.
