On May 31, 2023, the IRS issued REG-110412-23, additional guidance (the “Proposed Rules”) on the administration and interpretation of Section 48(e), an allocation-based investment tax credit (“ITC”) enhancement for projects located in specified low-income communities (the “Low-Income Community Enhancement”) that was enacted under the Inflation Reduction Act of 2022. Coming three months after the issuance of Notice 2023-17, which provided detailed mechanical guidance on how to apply for allocations of the Low-Income Community Enhancement, the Proposed Rules focus on defining key concepts in the ITC enhancement and refining the allocation process set out in the Notice to include significant preferences for certain owners and geographical locations.
The Proposed Rules are intended to apply to taxable years ending on or after the date that final rules adopting these Proposed Rules are published in the Federal Register. While the Proposed Rules are not available to be relied upon by taxpayers, they provide important insight into the potential content of the final rules and the current social priorities of the Treasury and the IRS.
Background
Assuming that certain labor-based requirements are met, the ITC for a solar or wind facility under Section 48 is generally equal to 30% of eligible basis. The Low-Income Community Enhancement increases this rate for four types of facilities: facilities located in census tracts that meet certain poverty rate and median income thresholds (“Low-Income Community Facilities”) and facilities located on tribal lands receive an additional 10 percentage points, while facilities installed on residential rental buildings participating in specified affordable housing programs where the financial benefits of the project’s electricity are allocated equitably among the occupants (“Qualified Low-Income Residential Building Facilities”) and facilities producing electricity 50% of the financial benefits of which are provided to households with income less than 200% of the applicable poverty line or less than 80% of area median gross income (“Qualified Low-Income Economic Benefit Facilities”) receive an additional 20 percentage points. The enhancement applies only to a wind or solar facility with a maximum net output of less than 5MW (AC) and is available only if an environmental justice solar and wind capacity limitation (“Capacity Limitation”), statutorily limited to an aggregate of 1.8GW for each of 2023 and 2024, and zero thereafter, is allocated to the facility by the Secretary of the Treasury.
Demarcating the Qualified “Facility”
For purposes of determining whether a facility has a maximum net output that exceeds the 5MW ceiling, the Proposed Rules aggregate multiple solar or wind energy properties or facilities into a single facility pursuant to the single-project factors in the “beginning of construction” guidance in Notice 2018-59 and Notice 2013-29. The Proposed Rules use similar factors to determine when energy storage technology is considered to be “installed in connection with” the wind facility or solar (or small wind) energy property for purposes of the enhancement: the energy storage technology and other eligible property must be owned by a single legal entity, be located on the same piece or contiguous pieces of land, have a common interconnection point, and be described in one or more common environmental or regulatory permits. In addition, the energy storage technology also must be charged at least 50% by the other eligible property (with this requirement deemed met if the power rating of the energy storage technology is less than two times the capacity rating of the connected wind facility (AC) or solar facility (DC)).
Defining “Financial Benefits”
In assessing whether the financial benefits of a Qualified Low-Income Residential Building Facility’s electricity are allocated equitably among the occupants, the Proposed Rules state that at least 50% of the “financial value of net energy savings” must be equitably passed on to building occupants, either through distributing equal shares among the designated low-income units in the property or by distributing proportional shares based on each dwelling unit’s electricity usage. If the facility and building are commonly owned, the owner must sign a benefits sharing agreement with the tenants, and “net energy savings” is equal to the greater of 25% of the gross financial value of the energy produced (taking into account separate pricing mechanisms for both self-consumed and exported electricity) or 100% of such gross financial value minus annual costs of facility operation. Where the facility and building are separately owned and the facility owner enters into a power purchase / energy services agreement with the building owner, “net energy savings” is equal to the greater of 50% of the financial value of the annual energy production by the facility accruing to the building owner (either via utility bill credit or via cash payments for net excess generation) or 100% of such financial value less payments to the facility owner for energy services associated with the facility. While tenants of sub-metered buildings must receive the financial value of utility bill savings as a credit on utility bills, tenants of master-metered buildings (who do not receive utility bills) must receive such savings through other means; in each case, applicants must follow guidance from the Department of Housing and Urban Development to ensure that the tenants’ utility allowances and annual income for rent calculations are not negatively impacted.
In assessing whether the financial benefits of a Qualified Low-Income Economic Benefit Facility’s electricity are provided to qualifying low-income households, the Proposed Rules require that the facility must serve multiple households and at least 50% of the facility’s total output must be distributed to qualifying low-income households, with a bill credit discount rate (taking into account the cost of program participation, e.g., subscription payments and other fees or charges) of at least 20% for each such low-income household. The Proposed Rules also provide guidelines for verifying the low-income status of such households.
Nameplate Capacity Test
For purposes of determining whether a qualified solar or wind facility is located in a low-income community, on Indian land or in an area meeting the Geographic Criteria (see below), the Proposed Rules require that 50% of the facility’s nameplate capacity (excluding the nameplate capacity of any energy storage technology installed in connection with the facility) must be in the qualifying area.
Revised Procedures for Capacity Limitation Allocations
Whereas Notice 2023-17 contemplated multiple 60-day application windows for calendar year 2023, the Proposed Rules currently contemplate an initial application window in which applications received by a certain time and date are evaluated together, followed by a rolling application process if the Capacity Limitation is not fully allocated after the initial application window closes. Consistent with Notice 2023-17, the Proposed Rules reaffirm that facilities placed in service prior to being awarded an allocation of Capacity Limitation cannot receive an allocation.
Crucially, the Proposed Rules create two criteria (collectively, the “Additional Selection Criteria”) that are significantly favored in the allocation process, the Ownership Criteria and the Geographic Criteria. The Ownership Criteria are met if a facility is owned by a Tribal Enterprise (i.e., an entity controlled by an Indian tribal government in specified ways), an Alaska Native Corporation, a qualified tax-exempt entity (e.g., tax-exempt organization, state or Indian tribal government, or cooperative furnishing electricity to rural areas), a renewable energy cooperative (i.e., a developer cooperative that owns at least 51% of the facility and is controlled by either low-income household members or worker-members, in each case, with equal voting rights), or a “qualified renewable energy company” meeting certain characteristics. Specifically, a qualified renewable energy company must be 51% owned by one or more individuals, a Community Development Corporation, an agricultural or horticultural cooperative, an Indian tribal government, an Alaska Native corporation or a Native Hawaiian organization, and must demonstrate certain solar and wind development experience as well as a relatively small size (less than 10 full-time equivalent employees and $5m in annual gross receipts for the previous calendar year). The Geographic Criteria are met if a facility is located in a Persistent Poverty County (i.e., 20% or more of residents have experienced high rates of poverty over the past 30 years, based on measures by the Department of Agriculture) or in a census tract that is designated in the Climate and Economic Justice Screening Tool as disadvantaged based on certain highly specific metrics. Under the Proposed Rules, subject to the IRS’ discretion to reallocate Capacity Limitation across categories and subcategories to maximize allocation, 50% of the total Capacity Limitation in each facility category would be reserved for facilities meeting at least one of the Additional Selection Criteria, with priority going to facilities meeting both criteria if there is a Capacity Limitation shortfall and a lottery system to be used to decide among similarly situated applications.
In addition, the Proposed Rules further subdivide the existing 700MW allocation to Low-Income Community Projects into a 560MW reservation for residential behind-the-meter facilities and a 140MW reservation for front-of-the-meter facilities; provide detailed documentation and attestation requirements, which vary depending on whether a facility exceeds 1MW AC and is front of the meter (versus behind the meter); and generally institute a recapture mechanism if the financial benefit requirements described above (if applicable) cease to be met, or if the facility output exceeds 5MW AC, during the five-year period after being placed in service.
The Proposed Rules create powerful preferences and requirements that, if implemented, could dramatically affect the dynamics of who receives the Capacity Limitation. Taxpayers are advised to monitor taxpayer comments for additional insights into how the IRS’ interpretation of the Low-Income Community Enhancement may continue to evolve.
For further information, please contact:
Judy Kwok, Partner, Linklaters
judy.kwok@linklaters.com
