New tax credits will benefit microgrids – if they follow the rules

After the Build Back Better bill stalled in Congress last year, many were surprised to see even a scaled-down version, in the form of the Inflation Reduction Act of 2022 (the Act), pass as it did. The Act tackles a wide range of issues, including cutting the deficit, putting controls around prescription drug prices, extending Affordable Care Act subsidies and promoting climate change mitigation efforts with a clean energy incentive program. 

In fact, more than half of the funding in the Act will be used for clean energy and climate investments, primarily in the form of two tax credits: the investment tax credit (ITC) and production tax credit (PTC). 

The tax credits are a boon for not-for-profits, such as municipal utilities, as they are now eligible for direct payments from the IRS and Treasury Department, i.e., it is a credit treated as taxes paid on a return. Still, microgrids and other utilities will have to navigate complex compliance requirements in order to maximize the tax credits. 

Tax credits 

ITCs for carbon-free energy are structured around a base rate, multipliers and bonus incentives.  

The base incentive for the ITC is 6% of the project’s cost basis, but there is a multi-tier credit multiplier, creating a 30% total ITC, if the project meets prevailing wage rules and uses qualified apprentices. That means any labor for construction, alterations or repairs within five years of being placed in service must be paid the prevailing wage as determined by the Secretary of Labor. Furthermore, a percentage of the work on the project (by labor hours) must be completed by qualified apprentices. It applies to most nonmanufacturing projects and increases from 10% for projects starting before Jan. 1, 2023, to 12.5% for projects starting during 2023, to 15% for projects starting after Dec. 31, 2023.  

Municipal utilities have the opportunity for a 2%-point bonus credit for ITC or PTC if domestic content rules are met for most renewable projects. However, this increased to 10% if the prevailing wage/apprentice 5x adder requirements are met. To fulfill this requirement, any steel, iron or manufactured product that is a component of the energy project (upon completion of construction) must be produced in the United States. For manufactured products used in the projects to be considered produced in the United States, at least 40% of the total cost of all manufactured products of such facility are attributable to products (including components) that are mined, produced or manufactured domestically. 

Renewable energy projects in energy communities also qualify for up to a 10%-point bonus credit. A brownfield site as determined by the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) would be considered an energy community. Another type would be a community involved with the extraction, processing, transport or storage of fossil fuels as well as a census tract that has, or adjoins a tract with, a closed coal mine or power plant. 

Low-income communities that have renewable energy projects qualify for the same bonus credit increase. Qualifying communities are Tribal lands and those in census tracts with a poverty rate of at least 20% or that have median family incomes that do not exceed 80% of area median income, as determined by U.S. Census data. 

Requirements for the various ITC bonuses are complex, and the IRS and Treasury will have their hands full in adjudicating the rules. 

Specific technical eligibility requirements for microgrids 

A microgrid project must meet several requirements to qualify for ITC. 

• Its generation capacity must be between 4 kilowatts (kW) and 20 megawatts (MW).  
• It must be capable of operating in connection with the electrical grid and as a single controllable entity.  
• Interconnection costs can be included as part of the investment costs for projects under 5 MW.  
• The microgrid has to be capable of operating independently and disconnected from the grid.  
• It cannot be part of the bulk power system, and,  
• It must be under construction by Dec. 31, 2024. 

Key takeaways 

Most of the tax credits granted by the Act can be used in conjunction with other grants from the Department of Energy and other funding platforms (though the credits cannot be claimed for property funded by certain grants from the Department of the Treasury), including those from the Infrastructure Investment and Jobs Act (IIJA) that prevent outages and enhance the resilience of the electric grid formula, as well as grants to states and Indian Tribes. Also, loan guarantees from the Energy Department’s Loan Guarantee Program would not be affected by the tax credits. 

It is important to note, the IRS and Treasury Department have not finalized the rules and interpretation of the law. Guidance is needed to clarify several areas of uncertainty; the timing of this guidance is unknown. 

Given the complexity of the tax credit platform, compliance with the rules must be built into the project development and procurement strategy to ensure contractors, equipment suppliers and other vendors meet the rules, such as the domestic content or qualified apprenticeship requirements, in order for the municipal utility or others to get the most out the expanded credit program.