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Tax Structuring for Monetizing Tax Credits Under the Inflation Reduction Act of 2022

The Inflation Reduction Act of 2022 provides tax provisions for energy security. Read on for a look at three common approaches to monetizing tax benefits/credits, as well as two new options.
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President Biden recommitted the U.S. to the Paris Agreement on day one of his administration. Under his leadership, the U.S. has declared its economywide net greenhouse gas emissions target for 2030 as 50 to 52% below 2005 levels. In furtherance of this goal, the Inflation Reduction Act of 2022 (IRA) was signed into law on August 16, 2022. The IRA allocates $369 billion to promoting energy security and combating climate change.

Tax provisions for energy security include new or extended production tax credits and investment tax credits for clean energy manufacturing, including solar power, wind power, and energy storage.

Production Tax Credits include:

  • Section (§) 45V – New Clean Hydrogen 
  • §45X – New Advanced Manufacturing 
  • §45U – Nuclear Power 
  • §45 – Renewable Electricity 
  • §45Y – New Clean Electricity

Investment Tax Credits include:

  • §48 – Energy Investment 
  • §48E – New Clean Electricity
  • §48C – Advanced Energy Project Credit

In general, developers of renewable energy projects have limited ability to use federal and state tax credits. Consequently, creative participants in the green energy space have developed structuring techniques to both finance these projects and distribute the resulting tax credits efficiently.

This article mentions the three most common approaches to monetizing tax benefits/credits and also looks at two new options that the IRA added to the investment mix.

Common Business Structures for Monetizing Tax Credits

Partnership Flips

Partnership flips are the most common structure in use today for monetizing clean energy tax credits. The IRS has issued guidance for solar and wind energy projects that claim federal tax credits. Revenue Procedure 2007-65 provides an illustration of a partnership flip structure typically seen.

The Flip Illustrated – Developer (D) and tax equity investor (TEI) form a tax partnership. The partnership agreement calls for a pre-flip period where TEI receives most income, deductions, and credits from the project and D receives all distributable operating cash flow until D receives its original investment. Then, TEI continues to receive most income, deductions, and credits, but during this second period all distributable operating cash flow goes to TEI until the flip date, the earlier of a date certain, or the date TEI reaches a previously determined internal rate of return on its investment. After the flip date, the allocation of distributable operating cash flow, income, deduction, and credits, if any, mostly goes to D.

In addition to stipulating minimum sharing ratios between and minimum unconditional investment by partners, the safe harbor provided by Rev. Proc. 2007-65 limits contingent consideration, purchase rights, sale rights, guarantees, and loans. Some of the risks posed by the partnership flip structure include 1) the existence of a valid partnership, 2) the classification of participants as true partners, and 3) the appropriateness of income, deduction, and credit allocations. IRS safe harbors are helpful for avoiding these risks and minimizing transaction costs; this is just one of many hurdles in the green energy investment space.

As can be seen, the strength of a tax partnership is the flexibility in allocating income and loss (and credit); the allocations of which may be independent from operating cash flow distributions.

Other common structures include:

  • Sale Leasebacks – D constructs a renewable energy project and signs a power purchase agreement with a customer. D sells the project and contract to TEI, who then leases the project back to D. TEI receives all the tax benefits, including tax credits and depreciation, along with the lease payments for the project. D operates the facility and receives all income over the lease payments to TEI. 
  • Inverted Leases (or Lease Pass-Through Agreements) – In the simplest case, D constructs a renewable energy project and leases it to TEI. D makes a federal tax election to treat TEI as the owner of the project for purposes of the tax credit and TEI claims the credit on its tax return. The lessor (D) receives the lease payments and claims all depreciation for the property. The lessee (TEI) entity receives the tax credits from the project based on its fair market value. The project reverts to the lessor (D) at the end of the lease at no additional cost.

Note: Leasing structures typically exclude claiming the production tax credit because the taxpayer must be both the owner of the assets and the producer of the electricity.

New investment alternatives provided by the IRA include:

  • Direct Pay – The investment and production tax credits have historically been nonrefundable. The IRA has introduced an election whereby applicable taxpayers may receive direct payment of their allocable share of federal tax credits. Applicable taxpayers are state and local governments, the Tennessee Valley Authority, Indian tribal governments, and Alaska Native corporations. Nonapplicable taxpayers may opt for direct pay for the following three credits: §45V – Clean Hydrogen, §45Q – Carbon Sequestration, and §45X – Advanced Manufacturing.
  • Transferability – The investment and production tax credits also have not been transferable in the past. The IRA provides that taxpayers (excluding the above applicable taxpayers) may sell these tax credits beginning after 2022 to unrelated taxpayers for cash. Once purchased, they may not be resold. 

There is no doubt a lot of investment in this area is coming down the pike over the next decade. The Solar Energy Industries Association states the Inflation Reduction Act is the most transformational clean energy policy in history. Although the common structures listed above will remain relevant moving forward, it will be interesting to see how direct pay and transferability will impact both the types of new investors and the relative importance of the existing tax structures in renewable energy projects.

If you have questions or need assistance, please reach out to a professional at Forvis Mazars or submit the Contact Us form below.

Read more articles from the Forvis Mazars' 2022 tax guide.

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