IRA's Energy Community Tax Credit ‘Adder’: IRS Releases Taxpayer-Favorable Guidance

The highly anticipated guidance for determining a “green” energy facility’s eligibility for the potentially valuable tax credit increase largely aligns with industry expectations, including by providing certainty on energy community qualification through IRS-published lists of eligible locations.

The Internal Revenue Service (IRS) and the US Department of the Treasury (Treasury) released Notice 2023-29 (Notice) on April 4, 2023, establishing rules for testing an applicable “green” energy facility’s eligibility for a bonus federal income tax credit amount (or “adder”) attributable to being located in an “energy community” as enacted under the Inflation Reduction Act of 2022 (IRA). The Notice clarifies that its rules are intended to serve the basis for forthcoming proposed regulations that will apply to taxable years ending after April 4, 2023, but that taxpayers may rely on the rules set forth in the Notice pending release of these proposed regulations.

Notice 2023-29 largely aligns with industry expectations for a facility’s eligibility for this potentially valuable additional credit amount, although the Notice also includes certain welcome taxpayer-favorable conventions and safe harbors. Critically, the Notice signals that the IRS and Treasury will provide certainty on which locations are energy communities by publishing lists of qualifying locations.

Energy Community ‘Adder’

As detailed in a prior Morgan Lewis LawFlash, the IRA made a host of changes to the Internal Revenue Code of 1986, as amended (Code), to significantly extend and expand federal income tax credit benefits for green energy production, storage, and other technologies. Among these changes were new bonus credit incentives, or adders, that can significantly impact the amount of the applicable tax credit.

One of these adders applies with respect to the Code Section 48 or 48E investment tax credit (ITC) or Code Section 45 or 45Y production tax credit (PTC) for eligible facilities located in (during any part of an applicable tax year) (PTC standard) or placed in service within (ITC standard) an “energy community.” Qualification for the energy community adder increases a facility’s otherwise applicable PTC rate by 10% or increases its ITC rate by 10 percentage points (or 2 percentage points if the facility is subject to and does not satisfy a separate prevailing wage and apprenticeship standard).

The Code defines an energy community as a location satisfying any of the following categories:

• A brownfield site (as defined in subparagraphs (A), (B), and (D)(ii)(III) of Section 101(39) of the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA)) (Brownfield Category)
• A metropolitan statistical area or non-metropolitan statistical area that has (or, at any time during the period beginning after December 31, 2009, had) 0.17% or greater direct employment or 25% or greater local tax revenues related to the extraction, processing, transport, or storage of coal, oil, or natural gas (as determined by the secretary of Treasury), and has an unemployment rate at or above the national average unemployment rate for the previous year (as determined by the secretary of Treasury) (Statistical Area Category)
• A census tract in which after December 31, 1999, a coal mine has closed, or after December 31, 2009, a coal-fired electric generating unit has been retired, or a census tract that is directly adjoining such census tract (Coal Closure Category).

Energy Community Categories and Locations

The Notice provides highly anticipated guidance on determining the location of energy communities.

For the Brownfield Category, the Notice largely reiterates the CERCLA-based standard set forth in the Code. The Notice also provides a safe harbor for Brownfield Category qualification based either on prior certification as a brownfield site or through designation via an ASTM E1903 Phase II Environmental Site Assessment (Phase II Assessment) or an ASTM E1527 Phase I Environmental Site Assessment (Phase I Assessment) for smaller facilities.

For the Coal Closure Category, the Notice elaborates on the categories of and standards for shuttered coal mines and coal-fired power plants to satisfy this standard. The Notice also states that the applicable census tracts for purposes of this category are those used by the Census Bureau for purposes of the 2020 census. An eligible directly adjoining census tract to a designated coal closure census tract must directly abut the coal closure census tract at least at a single point. The Notice provides a list of census tracts in the Coal Closure Category.

For the Statistical Area Category, the Notice provides critical guidance on the applicable location of a metropolitan statistical area (MSA) or non-metropolitan statistical area (non-MSA), as well as standards for measuring an applicable location’s relative employment from the fossil fuel power industry and its unemployment rate (as described below). The Notice does not provide guidance and instead solicits additional comments on how to determine fossil fuel tax revenue for an MSA or non-MSA, noting the challenges in identifying readily available public data tailored to the requirements of the Code.

• MSAs are determined in accordance with Office of Management and Budget (OMB) standards, which are updated every 10 years in accordance with the US census process. Non-MSAs are determined in accordance with US Bureau of Labor Statistics (BLS) standards. The Notice includes a list setting forth delineations of MSAs and non-MSAs.
• The level of employment from the fossil fuel industry in an MSA or non-MSA is determined via 2017 North American Industry Classification System (NAICS) industry codes, as set forth in the annual County Files of the County Business Patterns published by the Census Bureau, and listed in the Notice. The Notice lists the MSAs and non-MSAs satisfying this standard.
• An MSA’s or non-MSA’s unemployment rate is determined by using county-specific Local Area Unemployment Statistics published by the BLS and aggregating figures across the counties located in such MSA or non-MSA. More specifically, the unemployment rate is calculated by dividing the total number of unemployed individuals within the MSA or non-MSA by the total labor force in such applicable area. This guidance can be helpful in that it employs a pure aggregate calculation approach across an MSA or non-MSA, rather than, for example, an averaging convention based on each county’s own unemployment rate regardless of the population/eligible employment base of such county.
• The Notice helpfully recognizes the statistical data lag associated with unemployment information for a calendar year not being available on January 1 of the next year and the associated uncertainty for a facility intending to fit within the Statistical Area Category. Since annual unemployment rates for a calendar year are generally released in April of the following year, Treasury and IRS intend to annually publish a listing of MSAs and non-MSAs satisfying the fossil fuel industry employment standard (taking into account the unemployment standard requirement) each May. Each such listing will then determine the MSAs and non-MSAs that satisfy the fossil fuel industry employment standard (taking into account the unemployment standard requirement) for the 12-month period starting in May through April of the following year. For example, energy communities defined by the 2022 unemployment rates will be designated in May 2023, which designation will remain in place until the next update in May 2024.

Facility Location

The Notice provides that a facility is “located in” or “placed in service within” an energy community (and thus eligible for the adder) if it satisfies a test based on relative nameplate capacity in an energy community or, for non-electricity-generating or storage facilities (e.g., a fuel production facility, such as a biogas facility), a footprint test.

Under the nameplate capacity test, a facility is considered located or placed in service within an energy community if at least 50% of the facility’s nameplate capacity is in an energy community area based on the location of energy-generating units. The Notice provides a helpful attribution rule allowing offshore energy facilities, such as offshore wind facilities, to qualify for the energy community adder based on the location of facility land-based power conditioning equipment for transmission, distribution, or use that is nearest to the point of interconnection (such as a substation).

Under the footprint test, a facility is considered located or placed in service within an energy community if at least 50% of the facility’s square footage is situated in an energy community area.

Energy Community Qualification Timing – Beginning of Construction Safe Harbor

As mentioned above, the energy community adder applies only to an eligible facility that is located in (PTC standard) or placed in service within (ITC standard) an energy community. For the PTC, the Notice confirms that energy community qualification is determined separately for each year of a facility’s 10-year PTC period.

But, crucially, the Notice provides a “begin construction” safe harbor that deems a facility to be located in an energy community for the year in which a facility is placed in service and for the entirety of the 10-year PTC period, if applicable. Specifically, if a taxpayer “begins construction” in a location that is an energy community on its beginning of construction date, the location will continue to be considered an energy community for the duration of any ITC or PTC period.

The safe harbor is vitally important to projects looking to qualify for the energy community adder based on the Statistical Area Category, for which qualification depends on the unemployment rate published each year with respect to the relevant MSA or non-MSA.

The Notice confirms that the longstanding “begin construction” standards set forth in a series of IRS notices under the PTC and ITC, including as applied for purposes of the prevailing wage and apprenticeship standard, apply for this purpose.

Update: On April 7, 2023, the IRS materially revised the “begin construction” safe harbor without publicly highlighting its revision. Importantly, the revised Notice narrowed the scope of the “begin construction” safe harbor by providing that the safe harbor applies only to projects that “begin construction” on or after January 1, 2023. This change may complicate utilization of the safe harbor for projects relying on the Statistical Area Category that began construction prior to 2023 (such as those that sought to “beat the clock” on the application of the prevailing wage and apprenticeship standards).

If a project seeking to satisfy the Statistical Area Category falls outside the safe harbor because it began construction before 2023, such project must satisfy the unemployment test the year before the project is placed in service to qualify for an ITC, or with respect to a PTC, the year before each applicable credit year. In such a case, the project site’s status as an energy community may be uncertain until the unemployment data for such prior year is published by the BLS.

Takeaways

The Notice provides for critical certainty in location eligibility for the energy community adder through the IRS/Treasury annual certification process on the various components and subcomponents of eligibility. Such certainty should solve risk allocation disagreements with financing parties and parties to merger and acquisition transactions within the industry as to energy community eligibility. Prior to the Notice, ambiguity in the IRA allowed for the possibility of competing data sources, and associated IRA interpretation risks, as to the eligibility of a project for the energy community adder.

For the Statistical Area Category and projects for which the PTC is contemplated, the “begin construction” safe harbor is particularly welcome. Prior to the Notice, many investors had been unwilling to commit to funding that assumes eligibility for the energy community adder because of prospective year-by-year unemployment fact risk during each PTC year. For projects that fall outside the revised “begin construction” safe harbor, however, the potential uncertainty of such project’s site as an energy community may cause investors to hesitate on funding until unemployment data is published by the BLS.

Finally, for offshore wind projects, the Notice is especially helpful in confirming that the point of interconnection is the relevant geographic focus, rather than point of generation, for purposes of energy community qualification. Without this clarification, the IRA could be interpreted to preclude energy community qualification for almost all offshore wind projects irrespective of the communities that these projects serve given that their offshore power generation equipment will likely not be located in any census tract, MSA, or non-MSA.

For additional background on the green energy tax credits passed into law with the IRA, see our earlier LawFlash, Inflation Reduction Act Would Significantly Expand Federal Income Tax Benefits for Green Technology Industry.