The Inflation Reduction Act of 2022 marks a pivotal moment in the realm of clean energy investments, offering tax incentives for businesses and individuals to employ sustainable practices. The Act serves to incentivize taxpayers to invest in clean, renewable energy property by providing incentives in the form of tax credits and deductions. Certain incentives provided by the Act are discussed below.

Overview of the Inflation Reduction Act

Signed into law in August 2022, the Act sets the stage for tax incentives aimed at bolstering investments in clean energy property and facilities. The Act's implementing guidance, available on the IRS website, serves as a crucial resource for navigating its nuances and reaping its benefits.

The Act introduces a new base and bonus tax credit regime for certain tax credits, providing a framework for Clean Electricity Production Tax Credit (45Y) and Clean Electricity Investment Tax Credit (48E) post-2024. Also, the Act creates new tax credits, extends and modifies certain existing tax credits, creates new elections to monetize tax credits, and extends the credit carryback and forward period.

Tax credits and deductions for businesses and other entities include:

• Advanced Energy Project Credit
• Advanced Manufacturing Investment and Production Credits
• Alternative Fuel Vehicle Refueling Property Credit
• Clean Electricity Investment Credit
• Clean Electricity Production Credit
• Clean Fuel Production Credit
• Clean Hydrogen Production Credit
• Cost recovery for qualified clean energy facilities, property and technology
• Credit for Carbon Oxide Sequestration
• Credit for electricity produced from certain renewable resources
• Energy credit for solar and wind facilities
• Energy Efficient Commercial Buildings Deduction
• New Energy Efficient Home Credit
• Second-generation biofuel incentives
• Sustainable Aviation Fuel Credit
• Zero-Emission Nuclear Power Production Credit
  

Tax credits for individual taxpayers include clean vehicle and refueling property credits, and home energy credits.

Energy property include solar energy property, fiber-optic solar energy property, electrochromic glass property, geothermal energy property, qualified fuel cell property, qualified microturbine property, combined heat and power system property, qualified small wind energy property, geothermal heat pump equipment, waste energy recovery property, energy storage technology, qualified biogas, and microgrid controllers.

Observations and Impact

Since the Act's inception, observable trends underscore the surge in claiming tax credits across various sectors. Solar energy property, electric vehicle chargers, energy-efficient commercial buildings, and clean vehicle tax credits have seen significant traction, indicative of a shifting landscape toward sustainable practices.

Notably, markets facilitating the connection between buyers and sellers of clean-energy tax credits are emerging, catering to taxpayers not subject to passive activity rules. Partnerships and S corporations also find themselves in the realm of eligible buyers or sellers, offering flexibility in utilizing their allocable share of tax credits.

Direct Pay and Transfer Elections

Applicable entities who register with the IRS can elect direct pay from the U.S. Treasury. Applicable entities include any entity that is tax-exempt, state and local governments, Indian tribal governments, Alaska Native Corporations, Tennessee Valley Authority, rural electric cooperatives, U.S. territories and their political subdivisions, and agencies and instrumentalities of state, local, tribal, and U.S. territorial governments.

Taxpayers other than applicable entities who register with the IRS can elect on a timely filed original tax return to transfer energy credits to an unrelated person for cash. If the passive activity rules apply to the transferee, then the utilization of the transferred credit may be limited.

Eligible tax credits:

• Alternative Fuel Vehicle Refueling Property Credit (30C)
• Clean electricity production and investment credits (45Y and 48E)
• Clean fuel production credit (45Z)
• Energy credits (e.g., solar, wind, geothermal) (48)
• Qualifying advanced energy project credit (48C)
• Qualified commercial clean vehicle credit (45W) (direct pay only)
• Renewable Electricity Production Tax Credit (45)
• Zero-Emission Nuclear Power Production Credit (45U)

   

Taxpayers other than applicable entities can elect direct pay for up to five years for the following credits:

• Carbon Oxide Sequestration Credit (45Q)
• Clean Hydrogen Production Credit (45V)
• Advanced manufacturing production credit (45X)

Production and Investment Tax Credits

The production tax credit is based on the amount of renewable energy produced. For example, the credit for the production of electricity from renewable resources is based on the fixed rate per kwh and is claimed over a 10-year period after the date the facility begins production.

Whereas the investment tax credit is based on a percentage of the federal tax basis of the energy property when placed in service for federal depreciation purposes. For projects less than 5 megawatt, the eligible basis can include interconnection property to enable distribution and transmission of electricity produced or stored by the system.

Property eligible for production and investment tax credits include solar and wind technologies, municipal solid waste, geothermal (electric) and tidal—whereas property only eligible for the investment tax credit includes energy storage technologies, microgrid controllers, fuel cells, geothermal (heat pump and direct use), combined heat and power microturbines, and interconnection costs. And property only eligible for the production tax credit includes biomass, landfill gas, and hydroelectric, marine, and hydrokinetic property.

Base and Bonus Credits

Prevailing wage and apprenticeship provisions, exceptions, and bonuses targeting domestic content, energy communities, and low-income communities play a vital role in augmenting these tax credits, encouraging inclusive participation, and fostering sustainable growth.

For example, the investment tax credit base is 6% and the bonus credit is five times this amount, or 30%. The bonus credit applies when the maximum net output of the energy property is less than 1 megawatt, construction began before January 29, 2023, or certain prevailing wage and apprenticeship requirements are met.

The prevailing wage and apprenticeship bonus provision applies to the following credits:

• Advanced Energy Project Credit
• Alternative Fuel Vehicle Refueling Property Credit
• Clean Fuel Production Credit
• Clean Hydrogen Production Credit
• Carbon Oxide Sequestration Credit
• Energy Efficient Commercial Buildings Deduction
• Investment and production tax credits

Whereas prevailing wage (not apprenticeship) applies to the New Energy Efficient Home Credit and the Zero-Emission Nuclear Power Production Credit.

An additional 10% bonus credit is available for domestic content and energy communities (including brownfield sites), and an additional 10% or 20% bonus credit is available for energy property whose maximum rated output is less than 5 megawatts and located in a low-income community.

Certain code provisions may limit the ability of taxpayers to use energy credits. For example, the at-risk and passive activity rules apply to energy credits. However, if the credit is limited for the year the credit originated, the remaining amount is first carried back to the third preceding tax year, then the second preceding tax year and the prior tax year before carrying forward for up to 22 tax years.

Clean Vehicle Tax Credits

The Act includes clean vehicle tax credits for purchasing new, used, and commercial vehicles. Specific criteria, including battery capacity, gross vehicle weight rating (GVWR), assembly location, and manufacturer's suggested retail price (MSRP), determine eligibility. Additionally, the Act allows for the transfer of clean vehicle tax credits to registered dealers beginning in 2024.

To qualify for the New Clean Vehicle Credit, the taxpayer’s modified adjusted gross income for the tax year of purchase or the preceding tax year, whichever is less, may not exceed $300,000 for married filing joint filing status, $225,000 for head of household filing status, and $150,000 for other buyers. In addition, the vehicle may not be acquired for resale, final assembly must take place in North America, the GVWR must be less than 14,000 pounds, the battery capacity must be at least 7 KW and the MSRP may not exceed $80,000 for vans, sport utility vehicles and trucks, and $55,000 for all other types of vehicles. To achieve the maximum $7,500 credit, certain critical mineral and battery component requirements must be met; the credit is reduced by 50% when only one requirement is met.

To qualify for the Used Clean Vehicle Credit, the taxpayer’s modified adjusted gross income for the year of purchase or the preceding year, whichever is less, may not exceed $150,000 for married filing joint filing status, $112,500 for head of household filing status, and $75,000 for other buyers. In addition, the vehicle must be purchased from a licensed dealer (not for resale) for no more than $25,000, the sale must be the first transfer of the vehicle since new (other than to the original owner), the GVWR must be less than 14,000 pounds, and the model year must be at least two years old. The credit is 30% of the purchase price with a maximum credit of $4,000.

To qualify for the Commercial Clean Vehicle Credit, the vehicle must be made by a qualified manufacturer, purchased for business use in the United States (and not for resale) and either an electric or fuel cell motor vehicle or mobile machinery (including vehicles that are designed to perform a function of transporting a load over a public highway). The vehicle or machinery must be propelled by an electric motor with a battery capacity of at least 7 kwh if the GVWR is less than 14,000 pounds, or 15 kwh if the GVWR is 14,000 pounds or more. The credit is the lesser of 15% (hybrid) or 30% (no gas or diesel engine) of the cost of the vehicle, or the incremental cost of the vehicle, with a maximum credit of $40,000 ($7,500 if the GVWR is less than 14,000 pounds).

Alternative Fuel Vehicle Refueling Property Credit

The Act extended and modified the Alternative Fuel Vehicle Refueling Property Credit. Alternative fuels include electricity, ethanol, natural gas, hydrogen, biodiesel, and others. Qualified property is used to store or dispense alternative fuel into the fuel tank of a motor vehicle propelled by the fuel, or to recharge an electric vehicle.

The credit is available to individuals and businesses that place qualified refueling property into service during the taxable year in the United States. Effective January 1, 2023, qualified property must be installed in a qualified census tract (low-income or rural area).

The base credit is 6% of the cost of eligible property and the bonus credit is five times this amount, or 30% with a maximum credit of $100,000. The bonus credit applies when construction began before January 29, 2023, or certain prevailing wage and apprenticeship requirements are met.

For individual taxpayers, the credit is 30% of the cost of eligible property with a maximum credit of $1,000 per item.

Energy Efficient Commercial Buildings Deduction

Commercial building owners who place energy-efficient commercial building property (EECBP) or energy-efficient commercial building retrofit property (EEBRP) in service may elect to claim a tax deduction. In addition, the designer of the EECBP/EEBRP installed in buildings owned by tax-exempt entities, including certain government entities, Indian tribal governments, Alaska Native Corporations, and other tax-exempt organizations can be allocated the deduction.

EECBP/EEBRP consists of interior lighting systems; heating, ventilation and air conditioning (HVAC) and hot water systems; and the building envelope. The credit is claimed for the tax year in which such property is placed in service for federal deprecation purposes.

The deduction is limited to the lesser of the cost of the EECBP/EEBRP or $0.50 per square foot for a building that achieves a 25% energy savings, increasing by $0.02 per square foot for each percentage increase in energy savings above 25%, up to a maximum $1.00 per square foot for a building with 50% energy savings. These amounts are inflation adjusted each year.

A bonus credit of five times the above amounts ($2.50 to 5.00 per square foot) is available when certain prevailing wage and apprenticeship requirements are met. These amounts are inflation adjusted each year.

The depreciable basis of the commercial building is reduced by the deduction claimed.

New Energy Efficient Home Credit

The Act amended and retroactively extended the New Energy Efficient Home Credit, revised the credit amounts, and requires participation in certain Energy Star programs. The new law distinguishes between single-family and manufactured homes, and multifamily homes.

The tax credit is claimed by the person who has basis in the home during its construction and is claimed for the tax year in which the home is first sold or leased for use as a personal residence in the United States.

For single family homes and manufactured homes, the tax credit is $2,500 when the home meets certain Energy Star requirements and $5,000 when the home meets the Department of Energy (DOE) Zero Energy standards.

For multifamily homes, the tax credit is $500 per dwelling unit for each unit that meets the Energy Star requirements and $1,000 for each unit that meets the DOE Zero Energy standards. If certain prevailing wage requirements are met, the tax credits increase to $2,500 and $5,000, respectively.

The depreciable basis of the home is reduced by the deduction claimed. However, a low-income housing building is excepted, so there is no impact on the low-income housing tax credit (LIHTC).

Residential Energy Credits

Individuals investing in residential energy improvements can capitalize on tax credits available under the Act. From home improvement credits to clean energy incentives for existing and new construction, the Act offers a spectrum of opportunities for homeowners to embrace energy-efficient practices.

The residential energy credits are comprised of the Residential Clean Energy Credit (existing homes and new construction) and the Energy Efficient Home Improvement Credit (existing homes only) used as a personal residence.

The Residential Clean Energy Credit is 30% of the cost of solar panels, solar water heaters, fuel cell property, small wind energy property, geothermal heat pump property, and battery storage property.

The Energy Efficient Home Improvement Credit varies based on the type of home improvement. The aggregate yearly tax credit limitation is $3,200, comprising $1,200 for all building envelope components, home energy audits, and energy property, and $2,000 for electric and natural gas heat pump, water heaters, electric or natural gas heat pumps, and biomass stoves and biomass boilers.

Conclusion

The Inflation Reduction Act marks a paradigm shift in incentivizing clean energy investments. Its comprehensive framework of tax credits and deductions not only encourages economic growth but also fosters a sustainable future. As businesses and individuals navigate this landscape, the Act stands as a beacon, steering us towards cleaner and more efficient energy practices.

The Act's impact resonates across various sectors, fostering innovation, encouraging participation, and fostering a collective commitment to sustainable growth. In leveraging these incentives, stakeholders can propel themselves towards a greener, more resilient future, aligning financial gains with environmental stewardship.

Don L. Warrant, CPA, is a director at Freed Maxick. He has over 35 years of public accounting experience where he has obtained a broad background in manufacturing and distribution, real estate and construction, retail and wholesale trade, agribusiness, hospitality, and professional services. Don also provides tax advisory and tax compliance services to high net-worth individuals. Don leads the Firm's SALT practice which provides state and local tax advisory and compliance services in connection with sales and use tax, income and franchise tax, and tax credits and incentives. In addition, Don leads the Firm's Cost Segregation practice which provides tax savings in connection with investments in real estate. His leadership helps businesses and individuals navigate the complexities of tax credits, steering them toward a greener and financially resilient future.