Lauren Collins of Vinson & Elkins LLP provides an overview of the new tax credits designed to reduce greenhouse gas emissions in the Inflation Reduction Act.
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Host: David D. Stewart
Executive Producers: Jasper B. Smith, Paige Jones
Showrunner and Audio Engineer: Jordan Parrish
Guest Relations: Alexis Hart
David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: credits where due.
In August, President Biden signed the Inflation Reduction Act into law. Now, we've already taken a deep-dive into the corporate alternative minimum tax and the new IRS funding in earlier episodes, which we'll link to in the show notes.
This time we'll be looking at another major piece of the law, a collection of measures aimed at reducing greenhouse gas emissions using tax credits. To talk us through the new tax credit regime is Lauren Collins, a partner at Vinson & Elkins.
Lauren, welcome to the podcast.
Lauren Collins: Thanks. Very happy to be here. I've been living and breathing the Inflation Reduction Act for the past few weeks, so this is a timely and important topic.
David D. Stewart: Well, all right. I'm glad to have you here, and could you first of all tell us how big was the climate portion of the Inflation Reduction Act?
Lauren Collins: Well, I think if we're just going by page numbers, I want to say about half of the 700 plus pages, but you know, substantively it's huge, right?
Not to overstate things, this is really just an historic investment in energy and climate in the United States. We have never seen a tax bill of this scope hitting on energy. You read through it and there's really kind of something for everyone, particularly in the renewable and clean space.
There's dozens of provisions in here that are meant to encourage investment in renewables, in clean energy, in domestic manufacturing, in electric vehicles and electrification of our grid. There's just a ton in here.
If you look at some of the projections of the impact of the IRA, it's going to result in trillions of dollars of investment and if the interest that we've gotten from clients over the past six or so weeks is any indication, people are acting on this in real time and making commercial decisions based off of what was in the IRA.
David D. Stewart: Now, much of what we saw in the Inflation Reduction Act seems to have come from the stalled Build Back Better Act. So is that the case on the climate side?
Lauren Collins: Yeah, absolutely. I think if you compare it against Build Back Better, it looks very, very similar. There are some really important differences, though, but the basic idea is the same. There is an extended runway for tax credits for renewables, so essentially we have until 2033, if not longer, for these tax credits to be available for many industries, and that's very similar to Build Back Better.
Important differences— there's new labor requirements that are in there, and that is novel to this area of the tax code. Another big difference as compared to Build Back Better is some of the monetization techniques — which we can chat more about — the direct pay and the transferability. And what's not included in the IRA versus Build Back Better, which is very important, is a credit for transmission. That did not make it into the IRA bill, much to, I think, everyone's surprise and disappointment.
David D. Stewart: What is the credit for transmission?
Lauren Collins: In Build Back Better there was a tax credit for investment in transmission assets, so we have tax credits for, let's say, investing in a solar project, or wind, or geothermal, or nuclear, or hydrogen. The list goes on for all of these technologies that have a tax credit that you can find in IRA.
But how you actually move that electricity once you've generated it from these renewable or clean sources, it needs to go onto our transmission grid.
I think anyone that's kind of remotely paying attention to this stuff realizes that our transmission grid is in desperate need of upgrade, particularly if we're going to have the kind of upgrades and investments on the generation side that we expect the IRA to provide.
There's a bit of a missing piece. We've incentivized the generation side of the electricity, but what we've missed is how do we get that electricity to folks' homes.
David D. Stewart: Now, you mentioned this giving a longer runway. What did the tax credit landscape for renewables look like before the Act?
Lauren Collins: Sure, so before the Act we had a Production Tax Credit (PTC) and then Investment Tax Credit (ITC), and both of those credits were sunsetting, so basically you needed to have begun construction prior to a given date — that has passed — in order to be entitled to the full credit rate, and then eventually both the PTC and the ITC were going to sunset completely.
What the IRA did is it said, "These specific tax credits, the PTC and the ITC, are extended for any project that begins construction prior to the end of 2024," so it gives us a few more years.
Then once we get to 2025, we're going to transition to this new technology neutral regime where essentially any sort of asset class can qualify as long as the greenhouse gas emissions rate is zero. If you're any sort of clean energy or energy storage asset from and after 2025, you're eligible for a technology neutral credit regardless of whether you're listed as one of the specific assets that qualify, which is the way the current ITC and PTC are set up.
Then that technology neutral credit is available until at least 2033, probably longer. That's just kind of the minimum period of time, because the sunset date for that will start to phase down once we've hit greenhouse gas emissions in the country equal to 25 percent of what they are in 2022.
It would be amazing if we were to get there by 2032 or 2033. Probably a bit optimistic, so we probably have even more runway for these tax credits than we think. So it's probably 10 to 20 years of runway.
David D. Stewart: All right, so what kind of projects can we expect to be supported by these credits, and how big of a support are they?
Lauren Collins: I think we'll see some of our traditional renewable energy projects, especially over the next few years, being the main beneficiary of the credit, so solar and wind in particular are going to get a nice push from these credits, as will stand-alone storage.
The IRA added in stand-alone storage as a specific asset class that is eligible for the investment tax credit. Previously, you needed to have paired your storage with a renewable facility and there was some complicated rules to basically make them treated as one facility. They've gotten rid of that, so now you can put a storage facility basically anywhere on the grid and you'll get a credit for it, so I think solar wind storage, we're going to see a nice push for those assets over the next few years.
Kind of longer term, I think we'll start to see more hydrogen projects and more carbon capture projects.
The carbon capture credit, it existed under pre-IRA law, but IRA significantly expanded it. The credit amount is hyped up and the ability to qualify for the carbon capture credit, the threshold was reduced, so you can qualify for the carbon capture credit more easily. I think there's a number of carbon capture projects kind of in development or construction stage now and we'll hopefully see that come online in the next few years and they'll get the benefit of those credits.
Same for hydrogen. Hydrogen is definitely a development stage technology right now, but the IRA provided really beneficial incentives in the form of tax credits, particularly for green hydrogen. It's primarily hydrogen produced through electrolysis of water, and then that produces green hydrogen, and you get a powerful tax incentive for the production of hydrogen in that case.
We're aware of a number of hydrogen projects that maybe were kind of touch and go. With IRA we expect them to be much more economic, so hopefully we'll see those projects start to come online a few years out.
David D. Stewart: What kind of carbon capture technologies are we looking at in those projects?
Lauren Collins: You know, the cool thing about carbon capture is there's kind of a good amount of variety of technologies.
There's kind of traditional. You capture the carbon directly from an industrial facility and you inject it into a well in the ground. That's kind of the basic carbon capture technology, but we have all sorts of fun conversations with people that are developing direct air capture, for example, where you basically capture the carbon directly from the air.
Then we have conversations with people who are looking to capture carbon and then utilize it in a creative way and basically find a commercial market for the carbon that has been captured. I think that there's a lot of cool stuff out there.
The higher credit rates, particularly for direct air capture, you can get a credit up to $180 a metric ton of carbon captured, so it just starts to make those more creative types of assets more economic. I expect we'll start to see more creative ideas.
David D. Stewart: As I understand it, the IRA is both climate policy and industrial policy. Could you tell me about the labor requirements?
Lauren Collins: You set it up well. Right? There are these very powerful and long list of incentives for development of renewables and clean energy technologies and projects, but you don't just get those for doing the development itself.
If you want to take advantage of the full credit amount, you need to satisfy these labor requirements, and it's a little novel to have imposed these types of requirements into a tax credit because as you've highlighted, it's really pushing forth a policy agenda to pay prevailing wages, which is the first requirement, and to train our workforce in these renewable or clean energy jobs, which is the apprenticeship requirement, which is then the second piece.
Again, the prevailing wage requirement is the first piece of it, and what that says is that if you want the full credit rate available, you need to pay all of the laborers and mechanics that are on-site doing the actual development of the asset a prevailing wage. Prevailing wages are basically set up as Davis-Bacon Act wages, which is a concept through the Department of Labor, but it's new to the tax code. In order to be, again, eligible for the full credit amount, you need to pay prevailing wages.
Again, this is going towards kind of an overall policy perspective or goal of bringing good jobs to the United States. Now these are good paying stable jobs in a growing sector, and so we want to make sure that not only are we giving credits to the companies that are doing the development, but that the people that are actually on-site slinging hammers are paid appropriately.
The other piece is the apprenticeship requirement. This basically requires any developer that's looking to take advantage of one of these tax credits to at least use good faith efforts to employ a minimum amount of apprentices as part of the construction of the project, so we want to make sure people are paid well. We also want to make sure that we're training up our workforce to be able to kind of take on these important energy jobs in our communities.
David D. Stewart: I also understand that there is a way to get additional credits for certain developments.
Lauren Collins: Yeah, so there's these new bonus credits in the IRA. I think there's kind of three of them. There's a domestic content bonus, there's an energy community bonus, and there's a low income community bonus.
The domestic content bonus, it's basically a 10 percent bonus, so if we're thinking about the investment tax credit, the standard credit there let's say is 30 percent.
If you also qualify for the domestic content bonus, then you now have a 40 percent credit, and that's basically 40 percent of your capital costs that you've just gotten back as a tax credit, so it's super powerful. But of course in order to get that additional 10 percent, you need to make sure that the facility or the project that you've installed has a sufficient amount of domestic content.
The specifics there are that all the steel, all of the iron, and a minimum percentage of the manufactured products that make up the facility are U.S. manufactured. That percentage starts at 40 percent and then it ramps up over time. You need to again, be able to establish that all of the things that have made up your facility are coming from the U.S. and then if you're able to do that, you get an additional 10 percent.
Again, the other two, that's the energy community bonus and the low income community bonus. These are available based off of where your project or your facility is located.
On the low income community bonus side it's just that. If you're located in a certain low income community, you can be entitled to a 10 or 20 percent bonus, but that's only available for small projects.
Larger utility scale projects are not eligible for the low income community bonus, but they might be eligible for the energy community bonus, which basically all it's getting at is they want to encourage investment in communities that have traditionally been focused on oil or gas or coal, and if you're investing in a renewable or clean asset in one of these communities and helping to revitalize that community, or change some of the economy there, then you can get an additional 10 percent bonus.
If you are lucky enough to find a way to be eligible for all of these credits and all of these bonuses, you could have an investment tax credit as high as 70 percent. It might be close to impossible to thread the needle and be entitled to everything, but certainly there will be projects that will be eligible for a 50 percent tax credit because they've qualified for the full ITC, domestic content, and the energy community. Then you've basically again gotten back 50 percent of your capital costs in the form of a tax credit.
David D. Stewart: I understand that there was a change in the way that these credits could be claimed through, I understand like a transferability of the credits. Could you tell us about that?
Lauren Collins: Yeah, so as background, and everyone listening will know this, but in order for a tax credit to be valuable, traditionally you've needed to have a tax liability to offset it against. Otherwise you just kind of carry it forward until you do.
So what people have had to do in the past, particularly developers of renewable assets who oftentimes do not have a large tax bill, is partner with someone who does, and you'll hear that referred to as a tax equity investor. They'll enter into somewhat complicated partnership arrangements with folks that can monetize the tax credit, and that's a way that people have been able to take advantage of tax credits in this space historically.
What the IRA does is it says you can still do that, and there's many reasons why people will continue to engage in tax equity transactions, but it gives some additional options so that that's not the only path forward if you're looking to monetize a tax credit.
As you mentioned, there's transferability. It's really as simple as just selling the credit, so if you generate a credit, if you can find a willing buyer, you can agree on a price, you can sell the credit to a third party who will be able to take that tax credit and report it on his tax return against its own tax liability.You no longer need to enter into a complicated partnership type arrangement.
You can basically enter into— it's more like M&A (Mergers and Acquisitions), right? Here's a credit, or here's my asset, and I'm going to sell it to you for an agreed upon price. That's not to say it's going to be completely without transaction costs, because there will be plenty of transaction costs. These are still very sophisticated parties, and there will be reps and warranties and indemnities that need to be negotiated, but it's still another option apart from tax equity.
The third option that was added was direct pay. This is a little bit different from Build Back Better. In Build Back Better, you could do direct pay pretty much for any asset and regardless of what type of taxpayer you are, but the IRA changed it a little bit.
Direct pay is basically, it's just a grant. You've taken your tax credit and you've turned it into a cash payment from the government. You'll run that process through your tax return, but the impact's the same. It's just a cash payment.
The important limitation in the IRA, though, is that it's really kind of geared for tax exempts, state level governments, rural electric cooperatives, Indian tribes and a few others, but the people that can take advantage of it is significantly limited.
Exceptions to that, though, are five years of the hydrogen credit and the carbon capture credit. You can use direct pay for that period of time for those credits regardless of what type of taxpayer you are, which is very important for those technologies because again they're a little bit more novel, a little bit more development stage for some of them. It helps that they can do this kind of grant or direct payment instead of having to find a buyer or a tax equity investor.
You can also do direct pay for the advanced manufacturing production tax credit, which is basically a credit for domestic manufacturing, where you get a per dollar, per kilowatt type credit for renewable components that are produced in the United States.
David D. Stewart: Is there any sense yet about how soon we'll start to see new projects that are coming about specifically because of the Inflation Reduction Act?
Lauren Collins: Oh, I think it's already happening. I mean we're seeing lots of activity, lots of excitement. We're having conversations with clients multiple times a day that they're changing their behavior as a result of the IRA.
There was also some information this morning that was sent around, just at the firm internally, about the number of deals that are moving to the U.S. These are basically like manufacturing facilities that will be on-shored as a result of IRA. We're seeing this in real time.
I mentioned hydrogen too. We're seeing projects that had been kind of set aside. Now they're reinvigorated because of the Inflation Reduction Act, so it's happening. It'll remain to be seen the scale and how quickly some of these are actually executed, but the momentum is definitely there.
David D. Stewart: This bill also supports the development of nuclear power. Do you foresee that being something that gets taken advantage of, or does that require too much time and commitment?
Lauren Collins: An important nuance of the nuclear tax credit that is in IRA, I should say, is that it applies to facilities that are already in existence. So from my perspective that means that they don't want you to develop new nuclear, but they want you to keep the stuff that's already in existence around and operating, and for it to just continue to be a part of our energy mix in this country.
I think it goes without saying that our energy needs are only growing exponentially, so things like nuclear, things like renewables, even traditional oil and gas, there's kind of a space for everything, and I think the nuclear credit was a reaction to that. We need everything to kind of be all hands on deck if we're going to be able to make sure we satisfy our energy needs.
David D. Stewart: To the point of the energy needs and the other portion of this bill, which is to get down the amount that consumers are using, there are some tax credits available to individuals for energy efficiency. What sort of tax credits are they?
Lauren Collins: Yeah, so it's similar to the extension of the investment tax credit for businesses. There's also extension of the tax credit that homeowners are entitled to for energy property, so for putting a solar panel on your roof, for example. That tax credit has been extended.
There's also deductions available and credits available for, as you said, energy efficiency, so for example, installation of energy efficient windows or boilers or heaters. There's a place in the IRA for those benefits as well.
There's also electric vehicle credits. Those have been getting a lot of attention, of course. They're available for new and used electric vehicles, which is kind of cool. Oftentimes the code requires an asset to be new to get a credit. This is a different twist on that, so you can buy a used electric vehicle and get a tax credit. I believe it's up to $4,000 on your purchase.
David D. Stewart: Speaking of the electric vehicle credit, I understand that there was an older credit that's beginning to phase out and is being replaced by this new system that has a few more requirements on it.
Lauren Collins: Yes. No, you're absolutely right. There are some new requirements, and the requirements basically get at moving things to the U.S. I don't think it's any secret that a lot of the technology, and the minerals and materials and components that make up our electric vehicles do not come from the United States, so the credit is really contingent— Or I should say that a taxpayer's entitlement to the credit is contingent on the vehicle meeting certain domestic manufacturing requirements so that we're giving credits for things that have actually been assembled here in the United States.
On the flip hand, one of the things that improved in the electric vehicle credit is previously there was a cap per manufacturer, which is kind of a weird concept. But depending on which manufacturer you were you could kind of use up your cap sooner than later, and it might push people to buy one version of an electric vehicle versus another. They got rid of that, so that is an improvement, even though there is this additional limitation on requiring the vehicle to have been manufactured in the U.S., basically.
David D. Stewart: Now, turning back to the larger picture here, I know hearing from economists, they often talk about how a tax credit is the way to deal with climate change. This bill seems to be mostly carrots instead of the stick of a carbon tax.
Lauren Collins: Yeah. I think that's exactly right. This bill is just chock full of tax incentives. As we've talked about, there's a little bit for everyone and it's in the form of a financial incentive, so it's to encourage people to make investments, to change their manufacturing location, to electrify their assets. There is a piece of the IRA that imposes emissions and methane taxes and the like.
I'm very happy to say that I get to focus on the happy part of the bill, which is the credits and the incentives. I think it's a good way to come at it. As we've talked about, the energy mix really requires, or our energy needs require the energy mix to be diverse. Instead of a stick approach, where we're penalizing people for activities that are still important for our energy needs, we should just encourage more, and yes, encourage it in a responsible or renewable or green manner.
David D. Stewart: Are there any projections on expectations for how this bill will work? Is it going to meet the climate goals that the administration has set?
Lauren Collins: You know, just as a human being I hope so, right? I think our goals are ambitious for sure. I think that the main impediment as I see it, and this is from the perspective of a tax attorney, not an economist or an expert in energy needs across the country, but I think our biggest impediment is transmission.
I think we've done a really great job in the IRA of encouraging investment in generation, but again, how we get that generation to people's homes and businesses, that's the next hurdle that we need to figure out a way to overcome. Otherwise electricity is going to continue to be sparse and expensive. I think that's the next piece.
I don't know that that's going to happen through the tax code. It seems like what is needed there more is permitting reform, which as I understand it is in process as we speak. But it remains to be seen whether we get that figured out.
David D. Stewart: Well, Lauren, this has been great. I wish you the best of luck with the flood of new work coming your way. Thank you for being here.
Lauren Collins: Yeah, no, my pleasure, and if you know any good tax lawyers, send them my way because we are quite busy.
David D. Stewart: And now, coming attractions. Each week we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor in Chief Paige Jones. Paige, what will you have for us?
Paige Jones: Thanks, Dave. In Tax Notes Federal, Jasper Cummings explains why all acquisitions are bootstrap acquisitions. Robert Warren and Timothy Fogarty argue that refunding the IRS will make it functional again. In Tax Notes State, Marty Sullivan examines how state severance tax revenues have skyrocketed since 2007. Ethan Millar and Michael Giovannini provide updates from the fast-paced world of unclaimed property. In Tax Notes International, Stephanie Soong Johnston reports on Pascal Saint-Aman's planned resignation from the OECD at the end of October. Three Matheson practitioners examine the deductibility of digital services taxes in Ireland. And finally, in Featured Analysis, Ryan Finley argues that there are many possible grounds for appealing the bizarre transfer pricing method endorsed in Medtronic II.
David D. Stewart: That's it for this week. You can follow me online @TaxStew, that's S-T-E-W. And be sure to follow @taxnotes for all things tax. If you have any comments, questions or suggestions for a future episode, you can email us at firstname.lastname@example.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.