IRS Releases Guidance on Energy Community Requirements for Bonus Tax Credits
April 10, 2023
On April 4, 2023, the IRS issued Notice 2023-29 (“Notice”), which provides guidance on the amount of additional credit available to qualifying renewable energy projects located in specially designated energy communities (“Energy Communities”). The Inflation Reduction Act (“IRA”) provides for increased PTC and ITC amounts above the credit otherwise available under IRC sections 45, 45Y, 48, and 48E1 for projects that are located in Energy Communities (“Energy Community Adder”).2 The Notice provides much needed guidance on how Energy Communities will be defined, helping taxpayers identify locations that qualify under each of the following categories set forth in the statute: (i) brownfield locations (“Brownfield Category”), (ii) certain statistical areas with unemployment rates at or above the national average for the prior year that have (or have historically had) either a requisite percentage of direct employment in the fossil fuel industry or that derive or have derived a specified percentage of tax revenue from such industries (“Statistical Area Category”), and (iii) locations with a specified nexus to coal mine or coal generating plant closures (“Coal Closure Category”).
Energy Community Adder Generally
The IRA amended sections 45 and 48 and introduced new sections 45Y and 48E, which provide taxpayers with PTCs and ITCs with respect to qualifying renewable energy projects. Projects located in Energy Communities claiming PTCs or ITCs are eligible to claim an Energy Community Adder of 10 percent of the otherwise applicable PTC rate and up to 10 percentage points of the otherwise available ITC amount.3
Energy Community Categories
The Energy Community Adder is available to facilities located in an area that satisfies the requirements of one of the Energy Community categories described above. The Notice clarifies the meaning of such categories of Energy Communities as follows:
- Brownfield Category includes real property, the expansion, redevelopment, or reuse of which may be complicated by the presence (or potential presence) of a hazardous substance, pollutant, or contaminant and certain mine-scarred land.4
- Statistical Area Category includes metropolitan statistical areas (“MSAs”) and non-metropolitan statistical areas (“Non-MSAs”) that (a) have (or had at any time after December 31, 2009) 0.17 percent or greater direct employment in specified fossil fuel activities (“FFE Test”), or 25 percent or greater local tax revenues relating to certain fossil fuel industries (“Revenue Test”) and (b) had an unemployment rate at or above the national average unemployment rate for the previous year.5
- The Notice provides that the local average unemployment rate will be determined by reference to the Local Area Unemployment Statistics annual data from the BLS, which is generally released for the prior calendar year in April. The Department of Treasury and the IRS intend to issue an updated list of MSAs and Non-MSAs that qualify as a Statistical Area Category Energy Community each year in May. Although the Notice identifies the MSAs and Non-MSAs that satisfy the FFE Test as of the date of the Notice, because the unemployment rate prong of the test is determined by reference to the BLS guidance published in April, the list of MSAs and Non-MSAs that satisfy the Statistical Area Category requirements for 2023 are expected to be identified in an update to Appendix B of the Notice in May.
- Although the Notice clarifies the determination of how direct employment in certain fossil fuel industries is determined (e.g., setting forth the exact North American Industry Classification System industry codes applicable for this purpose), taxpayers that are seeking to qualify a project for an Energy Community Adder based on the alternative Revenue Test will have to wait. Because there is no obvious source for determining an MSA’s or Non-MSA’s percentage of tax revenue related to fossil fuel industries, the Notice solicits public comment on the appropriate data sources and methodologies for the Revenue Test.
- Coal Closure Category covers a census tract or a directly adjoining tract in which a coal mine was closed after December 31, 1999 or a coal-fired electric generating unit has been retired after December 31, 2009. The Notice elaborates on the definition of census tracts, closed coal mines, and retired coal-fired electric generating unit and clarifies that, for purposes of determining whether a census tract is “directly adjoining,” a census tract need only touch at any single point. The Notice lists the census tracts that satisfy the Coal Closure Category in Appendix C of the Notice. This guidance is consistent with the expectations of most tax practitioners given the relatively clear-cut nature of the statutory language and previous IRS guidance identifying Coal Closure Category Energy Communities for purposes of the section 48C advanced energy project credit.
“Located In” and “Placed in Service” Requirements
The Notice also clarifies the timing requirements relating to when a facility is “located in” an Energy Community (for purposes of the PTC) or “placed in service” within an Energy Community (for purposes of the ITC) so as to qualify for the Energy Community Adder.
- ITC Projects. As a general rule, ITC projects will be treated as located in an Energy Community if the relevant geographic location constitutes an energy community as of the placed in service date of the project. Importantly, there does not appear to be any requirement that the area remain an Energy Community for the duration of the ITC recapture period.
- PTC Projects. By contrast, the default rule for PTC projects is that the Energy Community test is made on a yearly basis during the 10-year PTC period for the project. Subject to the safe harbor discussed below, this means that production from a project may qualify for the Energy Community Adder in one year, but not qualify in a subsequent year if the location ceases to be an Energy Community. This is particularly relevant to the Statistical Area Category, as unemployment rates in an MSA or Non-MSA may be higher than the national average in one year, but lower in a later year. Although not inconsistent with the statute, it does add complexity to industry participants’ ability to effectively plan and model PTC rates for Statistical Area Category Energy Communities. The rule is less problematic for projects located in Coal Closure Category Energy Communities, as such Energy Communities are not defined by reference to a characteristic, such as the unemployment rate, that fluctuates during the credit period on annual basis. However, this rule has the potential to impact projects located in Coal Closure Category Energy Communities if the 2030 map of census tracts were to change such that a project is no longer situated in a qualifying census tract. The Notice expressly defines qualifying census tracts by reference to the 2020 census map, but it is unclear if the IRS will take the position a change in the census map for the 2030 census will apply for purposes of re-determining whether a project qualifies as located in a Coal Closure Category Energy Community under this year-by-year test.
- Beginning of Construction Safe Harbor. Notwithstanding the above, the Notice sets forth a beginning construction “safe harbor” providing that if a taxpayer begins construction of a facility after December 31, 2022 in a location that is an Energy Community as of the beginning of construction date, then, with respect to that facility, the location will continue to be considered an Energy Community for the duration of the credit period for PTC projects or on the placed-in-service date for ITC projects. For purposes of this safe harbor, the Notice directs taxpayers to the long-established beginning of construction guidance that has been issued by the IRS (beginning with Notice 2013-29). Although this safe harbor is a welcome development, given the concerns described above in connection with the year-by-year Energy Community test, the fact that the safe harbor is limited to those projects that begin construction after December 31, 2022 will significantly limit its application to many projects. In particular, many developers have taken steps to ensure that projects will be treated as beginning construction prior to January 29, 2023 in order for the project to be deemed to satisfy the wage and apprenticeship requirements introduced by the IRA. Often, the steps taken by the developer will result in the project being treated as having begun construction prior to January 1, 2023 and, therefore, ineligible for this safe harbor. As a result, industry participants will have to grapple with the issues raised by the year-by-year Energy Community test for a significant number of projects. Moreover, it would be helpful if the IRS would clarify the application of these rules to projects that begin construction through off-site activities. For instance, a taxpayer may incur costs with respect to project equipment in one year and allocate that equipment to a project in a later year. Often, a particular project will not have been identified in the year in which the costs were incurred. Under existing guidance, the project into which the “safe harbor equipment” is incorporated is treated as beginning construction in the year in which the taxpayer incurred the requisite percentage of project costs for safe harbor equipment. Confirmation from the IRS that this same rule would apply for purposes of the Energy Community safe harbor would provide taxpayers with greater certainty in applying this safe harbor.
Projects Partially Located in an Energy Community
- Another open issue for tax practitioners was how to address a project that is located only partially in an Energy Community. The Notice answered this question. For projects that have a nameplate capacity, the project will be treated as located in an Energy Community if 50 percent or more of the nameplate capacity of the project is located in the Energy Community. If a project does not have a nameplate capacity, the Notice applies a “footprint test” – treating the project as located in an Energy Community if 50 percent or more of the total square footage of the project is located in an Energy Community.
- The Notice also sets forth guidance on the substantiation requirements for taxpayers claiming the Energy Community Adder. A taxpayer claiming the Energy Community Adder must keep the relevant books and records establishing that a project is “located in” or “placed in service” in an Energy Community, as applicable, consistent with the requirements under section 6001.
In closing, the IRS intends to propose regulations regarding the Energy Community Adder, but taxpayers may rely on the rules described in the Notice pending the issuance of the forthcoming proposed regulations.
1 Unless otherwise indicated, all references to “section” herein refer to the Internal Revenue Code of 1986.
2 Our prior client alert describing developments with respect to the clean energy tax credits pursuant to the IRA can be found here.
3 Such 10 percentage point increase for ITCs is subject to taxpayers satisfying the prevailing wage and apprenticeship requirements (unless otherwise excluded from such requirements). ITC projects that do not satisfy the wage and apprenticeship requirements are only eligible for an increased ITC of 2 percentage points.
4 The Notice also provides a safe harbor for purposes of meeting the definition of a brownfield site.
5 MSAs are groups of counties or equivalents that are grouped according to the Office of Management and Budget as provided in Bulletin No. 18-03 (April 18, 2018). Non-MSAs are nonmetropolitan areas identified as such in the May 2021 Metropolitan and Nonmetropolitan Areas Definitions published by the US Bureau of Labor Statistics (“BLS”). For purposes of the Notice, Non-MSAs in Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont are defined as nonmetropolitan areas that have no portion in a MSA. The entirety of the Island Territories of American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, and the US Virgin Islands are each treated as one Non-MSA.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Arthur V. Hazlitt, an O’Melveny partner licensed to practice law in New York, Jeff Hoffner, an O’Melveny partner licensed to practice law in California, Alexander Roberts, an O’Melveny partner licensed to practice law in New York, Dawn Lim, an O’Melveny counsel licensed to practice law in New York, and Bo Chen, an O'Melveny associate licensed to practice law in the District of Columbia, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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