Passage of the Inflation Reduction Act of 2022 established Internal Revenue Code Section 45X, the advanced manufacturing production credit, and funded the long-depleted IRC Section 48C, the qualifying advanced energy project credit.
The intent of these
The IRC Section 45X credit is a function of each unit of specific types of domestically produced green energy components related to power generation, conversion and storage. Eligible components can include solar panels and related components, wind energy components, inverters for converting direct current to alternating current, and battery components such as modules, cells, electrode materials and critical minerals.
The Section 48C credit is a one-time credit based on the cost to build or reequip a facility used to manufacture or recycle a broader range of similar energy components, ranging from grid modernization equipment to equipment used to process sustainable liquid fuels. It even provides a general category of property designed to reduce greenhouse emissions.
The Section 45X credit can't be taken on production at a facility for which the Section 48C credit was taken. However, recent guidance states that for the purpose of 45X, an independently functioning production unit that produces an eligible component will be treated as a single facility. Therefore, a taxpayer may be able to claim Section 48C and Section 45X for different operations within the same location. Potentially eligible taxpayers should first perform an eligibility analysis of both incentives and weigh the benefits of each.
Funding for the Section 48C credit is $10 billion and allocated via a competitive application process with the U.S. Department of Energy. There will be two application rounds; the first phase of Round One begins no later than June 30 and ends July 31, 2023. The Section 45X credit isn't capped and can be claimed annually until fully phased out after 2032. The Congressional Budget Office had estimated that the Section 45X credit would cost approximately $31 billion, but there has been speculation that the cost may exceed this.
Project timing is a key factor for the Section 48C credit. The IRS announced the final allocation decisions for the first round could come as late as March 31, 2024. Companies have two years to place the property in service from the date the credit is awarded. However, the property cannot be placed in service prior to receiving an allocation letter, and doing so would invalidate the subsequent receipt of such an award. Therefore, projects that are already underway with expected completion before March 31 of next year may not be good candidates.
Recent guidance also states that the DoE may review Section 48C applicants to determine whether they have a connection with a country of risk. While no countries are specifically named, this provision could eliminate many otherwise good Section 48C credit candidates, as it is likely that many applicants have a large global footprint.
The Section 48C credit can be 6% of the cost of the property, or 30% if the prevailing wage and apprenticeship requirements are met. These types of large capital projects can commonly cost $100 million, which could generate a credit of up to $30 million. The magnitude of the Section 45X credit is best shown anecdotally, as the amount depends on production volumes, component type, and in many cases, the exact technical specifications of the components.
For a solar module manufacturer, a modest production level for a midsized facility would be 2 gigawatts per year, which would equate to producing 5 million standard 400-watt residential panels per year. Such production could generate an annual tax credit of around $140 million. For a manufacturer of eligible 15 kilowatt-hour home battery storage systems, annual production of 10,000 units could generate an annual credit of $15 million. This holds true even if the manufacturer purchases the individual battery cells from a third party that manufactures the cells outside the United States. For a manufacturer of eligible 200-watt microinverters, a yearly production volume of 5 million units could generate an annual credit of over $100 million.
The prevailing wage and apprenticeship requirements associated with the IRC Section 48C credit involve a level of complexity and consideration that is entirely new to tax law. Obtaining the five-times-higher credit rate requires the general contractor and major trades to meet requirements at the worker level basis and also that the taxpayer be given access to the compensation data needed to prove the requirements are met.
The technical technicalities
Both incentives carry highly complex technical implications from both an engineering and accounting perspective. In the case of Section 48C, the discretionary application process begins with the submission of a technical business case, known as a concept paper, which, if successful, would be followed by a subsequent detailed application submission. Both submissions require highly technical information on the products as well as anticipated emission reductions.
For Section 45X, a component's eligibility, as well as the specific credit rate, can hinge on complex technical specifications. For example, battery module eligibility depends on the specific energy density of the cells being used, as well as the overall capacity and use of the system. Unique situations will certainly arise where eligibility will not be clear based on the nature of the product and will require careful technical analysis.
The Section 45X credit requires that the eligible components be sold to an unrelated person during each taxable year but will allow taxpayers to elect to sell to related persons where the sales are deemed as having been made to unrelated persons. These provisions leave questions unanswered, such as what this means for companies that both build and retain ownership of the eligible components. Examples include electronic vertical takeoff and landing companies that will both operate and build the aircraft, including their large battery modules, as well as battery energy storage systems manufacturers that build and lease these systems.
Companies that use domestic contract manufacturers for their products have requested guidance as to which party is entitled to claim the credit under these arrangements. Some of these companies have submitted comments arguing they should be entitled to the credit because they are the producer of the eligible components and have pointed to arguments that were once applicable to the Domestic Production Activities Deduction. No guidance has been issued to date.
However, if the IRS views the credit as specifically for manufacturers, the credit will likely go to the contract manufacturers in these situations. These credits are largely intended to bring clean energy manufacturing to the United States. Generally, the contract manufacturer, not its customers, can move manufacturing operations to the U.S. Additionally, some contract manufacturers may have foregone the Section 48C credit to remain eligible for the Section 45X credit.
One thing that can be said about these two provisions is that they seem to be working: Since the passage of the Inflation Reduction Act in August 2022, there has been a steady stream of press releases announcing new manufacturing facilities being built in the U.S. for these purposes. In fact, examples exist of companies with no U.S. presence prior to the passage of the act establishing a large manufacturing operation in the country and beginning production within nine months.
