Maximizing the value of IRA tax incentives while minimizing investment compliance risk

The IRA is the single largest investment in clean energy in U.S. history, but industry will only benefit from the estimated $1.2 trillion in incentives if the tax credits can be monetized.

This article originally published on Utility Dive

By Charles Dauber | April 8, 2024

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Charles Dauber is CEO and founder of Empact Technologies.

The Inflation Reduction Act is the single largest investment in clean energy in U.S. history, but industry stakeholders will only benefit from the estimated $1.2 trillion in incentives if the tax credits can be successfully monetized. Beyond the hype and excitement about the IRA’s potential, are very technical qualification requirements and costly risks of non-compliance. Developers and investors of community and utility-scale projects can make the most of these incentives by understanding the nature of tax credit compliance and its impact on transferability. Knowing how to monetize with tax equity structures or via the new transfer rules can reduce risk and maximize the value of IRA tax incentives. 

Risk amplification 

The IRA compliance requirements are very complex and constantly undergoing revisions, opening the door for potential missteps. When tax credits are sold either as part of a structured tax equity investment or by using the new IRA transfer rules, the risks of non-compliance are amplified. To cover this risk, investors increase the discount they apply to the tax credit value, resulting in the developer selling their tax credits at less than the maximum potential value.

Monetization math 

The IRA tax credit incentives have tremendous appeal. Solar and other renewable power projects have an opportunity to obtain a 30% tax credit. Projects can then layer on adders like domestic content (10%), energy community (10%) for projects located in a defined energy communities location, and the low-income communities bonus credit for eligible solar and wind facilities (10%). Altogether, a project sponsor could enjoy a tax credit incentive benefit of up to 60% of the total project cost. 

Transferability risks and realities 

Achieving this level of monetization, or even the base 30%, is another story. To attain the full 30% tax credit rate, projects must meet prevailing wage and apprenticeship compliance requirements. To comply with the PWA requirement, “taxpayers seeking an increased credit or deduction amount must ensure that laborers and mechanics employed by the taxpayer, or any contractor or subcontractor in the construction, alteration or repair of a facility, are paid prevailing wages” as set by the U.S. Department of Labor. On top of this, developers aiming for the domestic content credit need to prove that 100% of any steel or iron products were manufactured in the United States and that 40% of their manufactured products cost is composed of U.S.-made components. 

Maximizing monetization 

Getting the most out of tax credit incentives begins with the PWA. It’s critical that a PWA compliance system is put in place prior to construction. A dedicated IRA management platform can monitor and report progress to ensure compliance and minimize risk. From there, a developer can focus on maximizing the potential of IRA adders. A project that covers each of these areas has the highest likelihood of attracting tax equity investors and premium rates for tax credit transfers.

The investor scenario 

Tax equity investors and corporate tax credit transfer buyers are on the hook for any IRS audit failure, loss of tax credits or penalties for non-compliance. Therefore, because of this risk, investors assess each project for the degree of audit risk and protect themselves in two main ways. First, they may ask a developer to provide indemnifications, such as tax credit insurance, to protect the investor in the case of an audit. Insurance is expensive and difficult to obtain, and insurers expect that developers will actively manage compliance. Second, an investor will increase the discount of tax credit purchase value as a form of self insurance, reducing the value of the credits and the monetization of the IRA opportunity for developers. 

To illustrate, picture a utility-scale developer with a 30 MW solar project and $30 million capex, who generates $10 million in tax credits. Investors will discount the amount based on their financial return requirements along with the perceived amount of risk involved in the investment, including the risk of audit recapture. A developer who can assure the investor that the project is de-risked will be able to sell the tax credits at less of a discount. To reduce a tax credit discount amount and optimize the potential of tax credit incentives, developers need to be proactive in managing risk.

Mitigating risks 

As part of the IRA, the IRS received $80 billion in new funding, with over half of the investment allocated to enforcement. Investors are bracing themselves for painstaking scrutiny on tax incentives in general and PWA specifically. The risk of failing an IRS audit is a growing concern. 

Due diligence from day one is key to mitigating audit risk. Tax equity investors and corporate entities utilizing the tax credit transfer market are typically far removed from project engineering, procurement and construction and contractors and are not subject matter experts in the intricacies of PWA compliance. However, these investors will be liable for any error, omission or lack of compliance. Without an active compliance verification process from the onset of a project, investors may be assuming more risk than they wish to carry. 

The bridge between developers and investors

Creating a proactive compliance management program empowers tax credit investors with tools to mitigate IRA recapture audit risk. In turn, the reduction in risk helps developers receive a higher value for their tax credits.

IRA compliance management systems provide developers and investors the assurance that their projects will comply with the full prevailing wage and apprenticeship and domestic content requirements as well as requirements for additional tax credits like the energy community and low-income community adders. By leveraging IRA compliance software and data analytics, developers can capture required data from project EPCs and contractors, and actively manage resolution of any identified prevailing wage or apprenticeship issues. Similarly, project suppliers can confidentially provide steel, iron and product cost data to enable domestic content qualification.

By creating a compliance data repository, developers can enable tax credit investors to streamline the due diligence process and protect themselves from IRA recapture risk through the 5- or 10-year recapture audit period.

The bottom line — an IRA compliance management program is the electronic bridge between developers and investors, turning an IRA opportunity into an IRA reality.