Impact of ‘beginning of construction’ on Inflation Reduction Act credits

Editor: Christine M. Turgeon, CPA

The Inflation Reduction Act of 2022, P.L. 117–169, enacted on Aug. 16, 2022, creates, extends, and expands numerous tax credits to incentivize clean energy and provides many opportunities to significantly boost those credits. The act’s tax credits are structured into tiers with a base rate, bonus credit amounts, and multipliers. The bonus credit amounts are available for meeting certain requirements, such as sourcing materials domestically or locating facilities in certain areas.

Further, if taxpayers meet prevailing wage and apprenticeship (PWA) requirements, a five–times multiplier is applied to both the base rate and any applicable bonus credit (Sec. 45(b)(6)(A)). However, as discussed below, taxpayers may be able to claim the PWA multiplier for certain credits if a project’s “beginning of construction date” is before Jan. 30, 2023.

Significance of the ‘beginning of construction’ date for the PWA multiplier

Taxpayers are able to claim the PWA multiplier without meeting PWA requirements if the project began construction before Jan. 30, 2023, (Notice 2022–61) and if continuous construction efforts are made, as described below. The PWA requirements otherwise would require (1) the taxpayer (and its contractors/subcontractors) to pay the workers constructing, altering, or repairing facilities prevailing wages, as set by the Department of Labor for similar work in that location and (2) no fewer than an applicable percentage of the taxpayer’s total labor hours for construction, alteration, or repair to be performed by qualified apprentices (labor–hours requirement) (Secs. 45(b)(7) and (8)). Each contractor or subcontractor that employs four or more individuals to perform construction must employ at least one qualified apprentice (participation requirement) and must maintain a required apprentice–to–journey worker ratio (ratio requirement).

Observation: The PWA multiplier can be applied to various clean–energy credits, including the Sec. 30C credit for alternative fuel vehicle refueling property, the Sec. 45 production tax credit (PTC) for electricity from renewable resources, the Sec. 45Q carbon oxide sequestration credit, the Sec. 45V clean hydrogen PTC, the Sec. 45Y technology–neutral PTC for clean electricity production, the Sec. 48 energy investment tax credit (ITC), the Sec. 48E technology–neutral clean–electricity ITC, and the Sec. 179D deduction for energy–efficient commercial buildings. If construction began before Jan. 30, 2023, taxpayers are exempt from the PWA requirements needed to qualify for the five–times multiplier for any of these credits. Therefore, it is essential to accurately determine and document when construction begins.

Establishing the ‘beginning of construction’ date

The IRS, in Notice 2013–29 and Notice 2018–59, outlines two methods for taxpayers to determine if construction on energy property has begun. Construction is deemed to have begun on the date the taxpayer first satisfies one of the two methods — the physical–work test or the 5% safe harbor (Notice 2018–59, §3.02). Both methods are subject to a “continuity requirement” under which, once construction has begun, there must be “continuous progress towards completion” (Notice 2018–59, §3.01). Notice 2022–61 applied these methods to the PWA requirements, effective Jan. 30, 2023.

The physical–work test provides that construction of a facility/energy property “begins when physical work of a significant nature begins,” and requires that the taxpayer maintain a continuous program of construction (Notice 2018–59, §§4.01 and .02). This test focuses on the nature of the work, not costs incurred, and has no minimum thresholds (Notice 2018–59, §4.02). Notice 2018–59 provides a lookthrough rule for Sec. 48 under which “both on–site and off–site work (performed either by the taxpayer or by another person under a binding written contract) may be taken into account for purposes of demonstrating that physical work of a significant nature has begun” (Notice 2018–59, §7.04(1)).

The 5% safe harbor provides that construction of a facility/energy property will be considered to have begun if (1) a taxpayer pays or incurs 5% or more of the total cost of the facility/property and (2) makes continuous efforts to advance toward completion (Notice 2018–59, §5.01). Generally, under an accrual method of accounting, construction costs will be treated as incurred in the tax year “in which all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability” (Regs. Sec. 1.461–1(a)(2)). With respect to property provided to the taxpayer, economic performance generally occurs as the property is provided to the taxpayer.

However, the lookthrough rule provides that, for purposes of meeting the 5% safe harbor under Sec. 48, if energy property or its components “are manufactured, constructed, or produced for the taxpayer by another person under a binding written contract,” any amounts paid or incurred by the other party (before it is delivered to the taxpayer) are considered as paid or incurred by the taxpayer at the time the other party incurs those amounts (Notice 2018–59, §7.04(2)).

Observation: Taxpayers’ overall method of accounting (e.g., cash or accrual) will determine whether to use “paid” or “incurred” for purposes of substantiating the date construction began under the 5% safe harbor, including the lookthrough rule. Taxpayers should evaluate their overall method as well as their accounting method for specific items (e.g., contractor liabilities under Sec. 461 and construction costs under Sec. 263A) in determining project costs, as incorrect or impermissible methods could create beginning–of–construction risk, tax exposure, and potentially financial statement risk.

Applying ‘beginning of construction’ to Sec. 48/48E credits

Sec. 48 focuses on investments in qualifying energy property — such as solar, geothermal, biogas, waste, microgrid controller, energy storage, and other clean–energy technologies — and requires construction for most energy property to begin before 2025 (Secs. 48(a)(3) and 48(a)(5)(C)). In contrast, Sec. 48E focuses on investments in clean–electricity facilities that have a projected greenhouse gas emissions rate of zero or lower that are placed in service after 2024 (Secs. 48E(a) and 48E(b)(3)).

The timing of when construction begins plays a crucial role in determining eligibility for certain tax credits, particularly due to the partial sunsetting of the Sec. 48 ITC and Sec. 45 PTC. Certain facilities for which construction begins after 2024 will no longer qualify for the Sec. 45 and 48 credits; instead, “qualified facilities” will be subject to rules under the new Sec. 48E ITC and Sec. 45Y PTC.

Observation: Taxpayers that are planning to claim credits for certain nonelectric technologies, such as qualified biogas property, should consider establishing sufficient records that support construction beginning by Dec. 31, 2024.

As discussed above, the 5% safe harbor provides that construction is deemed to have begun if a taxpayer pays or incurs 5% or more of the total cost of the energy property (including the lookthrough rule). Under Notice 2018–59, Section 7.01(2), multiple energy properties that are operated as part of a single project will “for purposes of determining whether construction of energy property has begun for purposes of the [Sec. 48] credit … be treated as a single energy property.”

Initially, Prop. Regs. Sec. 1.48–13(d)(1) would have provided that “multiple energy properties will be treated as one energy project” if “at any point during the construction … they are owned by a single taxpayer” and if at least two of the following factors were present with respect to the properties: (1) They are constructed on contiguous pieces of land; (2) they were described in a common power purchase, thermal energy, or other off–take agreement or agreements; (3) they have a common intertie; (4) they share a common substation or thermal energy offtake point; (5) they are described in one or more common environmental or other regulatory permits; (6) they are constructed pursuant to a single master construction contract; or (7) they are financed pursuant to the same loan agreement.

The final Sec. 48 regulations, however, require that four or more of these factors be present and that the taxpayer may assess these factors at any point during construction or during the tax year the energy properties are placed in service (Regs. Sec. 1.48–13(d)(1)).

Observation: Taxpayers should be aware that starting construction on just one energy property under Sec. 48 could be regarded as beginning construction on the entire energy project. It is important to consider the timing of evaluating these factors to benefit from bonus credits and the PWA multiplier. Additionally, taxpayers should carefully consider the lookthrough rule under the physical–work test and the 5% safe harbor for Sec. 48 credits when trying to determine when construction is deemed to begin. Lastly, if a project is considered to have begun construction under Sec. 48 but fails to meet the continuity requirement, taxpayers may need to reassess the project to determine if the facilities qualify under Sec. 48E.

A crucial consideration

The beginning of construction is a triggering event that can significantly affect credit eligibility under Secs. 48/48E or Secs. 45/45Y, as well as the amount of credit taxpayers can claim through the PWA multiplier or multiple energy properties that are operated as part of a single project. Therefore, it is crucial for taxpayers to consider the beginning of construction when dealing with Inflation Reduction Act credits, particularly under Secs. 45/45Y and 48/48E.

Editor

Christine M. Turgeon, CPA, is a partner with PwC US Tax LLP, Washington National Tax Services, in New York City.

For additional information about these items, contact Turgeon at christine.turgeon@pwc.com.

Contributors are members of or associated with PwC US Tax LLP.