The Section 45 Production Tax Credit (PTC) is one of the pillars of the U.S. federal government’s initiative to encourage renewable energy. Created under the Internal Revenue Code, the PTC provides a per-kilowatt-hour (kWh) tax credit on electricity produced from qualified energy resources. Since the Inflation Reduction Act (IRA) was signed into law in 2022, the PTC has seen major improvements, such as higher credit rates and broader qualifications. This article presents an in-depth guide to compliance and monetization of the Section 45 Production Tax Credit, offering benefits to both beginners and experienced professionals working in the renewable energy industry.

Understanding Section 45 Production Tax Credit: The Basics

Listed below are the basics to cover to ensure compliance:

Eligibility Requirements

A facility should:

Generate electricity from eligible energy sources like wind, biomass, geothermal, landfill gas, municipal solid waste, hydropower, and marine and hydrokinetic energy.
Be put into service within the prescribed time frames as set by the IRS.
Sell the electricity to an unrelated third party within the taxable year.

Credit Amounts

The Section 45 Production Tax Credit is a tax credit per kWh of electricity sold and generated. The credit levels are indexed for inflation annually. For example, properties that were put into service before January 1, 2022, qualify for:

75 cents per kWh for geothermal, closed-loop biomass, and wind.
5 cents per kWh for trash, landfill gas, open-loop biomass, qualified hydropower, and marine and hydrokinetic energy.

Advanced Compliance Considerations

The following factors are crucial for Section 45 Production Tax Credit compliance:

Prevailing Wage Requirements

Under Section 45, specific laborers have to be paid a minimum prevailing wage as specified by the U.S. Department of Labor (DOL). These rates are different by area, job class, and type of construction and are posted at www.sam.gov. It’s necessary to use the proper wage determination depending on when construction commences. In the absence of an applicable rate, a supplemental wage determination should be requested from the DOL.

Apprenticeship Requirements

A percentage of total construction, alteration, or repair labor hours must be done by qualified apprentices:

5% for projects that started construction in 2023
0% for projects commencing in 2024 and later

Exceptions to PWA Compliance

Two exceptions enable projects to qualify for five-times credit multiplication without prevailing wage and apprenticeship (PWA) compliance:

Start of Construction: Those projects that commenced before January 29, 2023, are exempted, except for credits under Sections 48C and 45Z.
One Megawatt Threshold: Projects under Sections 45, 48, 45Y, or 48E are exempted if their peak net output or storage capacity is less than one megawatt.

Monetization Strategies

The Inflation Reduction Act (IRA) brought with it a revolutionary mechanism for monetizing tax credits for renewable energy by making them transferable, providing an easier option compared to conventionally lengthy structures like tax equity financing. Such monetization methods are required to harness the financial potential of tax credits in Section 45 Production Tax Credit (PTC) and 48 (ITC), particularly for sponsors and developers who lack sufficient tax exposure to utilize the credits directly.

Tax Equity Transactions

Prior to the IRA, it usually took structured financing agreements between sophisticated parties and legal vehicles to monetize tax credits. The most prevalent of these was the partnership flip tax equity transaction. In this arrangement, two parties enter into a partnership: the sponsor member, often the developer, and the investor member, often a financial institution with the right tax appetite.

The investor provides capital, usually about one-third of the entire funding of the project, in return for the lion’s share (as much as 99%) of the tax credits, which consist of ITCs, PTCs, and accelerated depreciation. This method permits the sponsor to receive the credits upfront while postponing long-term asset benefits.

A period of time later, the investor’s portion of returns “flips” on either a target return (yield-based flip) or a fixed time period (time-based flip). Once flipped, the investor’s portion of credits usually falls to 5%, and the sponsor recaptures control of most of the project’s cash flow and tax characteristics. The sponsor frequently will purchase the investor’s interest at fair market value after the flip.

Although successful, tax equity transactions are complex and are associated with high transactional expenses. In the past, they have been accessible only to major projects involving sophisticated developers and investors familiar with dealing with the legal and tax sophistication of such arrangements.

Transferability under Section 6418

Section 6418, added to the IRA, provides for direct transfer of eligible tax credits to third parties in consideration of cash. This feature greatly reduces the entry point to realizing tax credits and expands access to developers, particularly those developing smaller to mid-scale projects that did not have the size to entice tax equity investors before. Key elements of transferability are:

Cash-Only Transactions: The credit has to be sold in cash, and the sale must include unrelated parties.
Non-Taxable Income: The cash obtained from the sale of credits is not taxed as the seller’s gross income.
No Deduction: Purchasers are not allowed to deduct the cost of purchase as an expense.
Single Transfer: Once the first transfer takes place, credits cannot be transferred to another person.

This new process has rationalized the tax credit market. Buyers will buy credits at a discount, usually 10% to 20%, providing a tax arbitrage opportunity. For example, a buyer may pay $85,000 for a $100,000 credit and use the entire amount to pay federal tax liabilities. The seller gains immediate liquidity, and the buyer saves their tax bill at a discount.

Furthermore, the advent of digital tax credit marketplaces and intermediaries has also streamlined the process further, facilitating improved price discovery, standardized documentation, and compliance assistance for both sellers and buyers. These marketplaces are democratizing access to tax credit monetization, placing more capital into clean energy projects, and opening participation to those beyond traditional institutional participants.

Wrapping Up!

Section 45 compliance and monetization have changed extensively due to transferability under the IRA. From tax equity transactions involving complicated deals to simpler credit transfers, developers enjoy increased financing options in green energy projects. Familiarity with prevailing wage, apprenticeship regulations, and monetization strategies is necessary for optimal tax benefits and risk reduction. Stakeholders can unlock immense value and speed up the shift to renewable energy through accurate planning and documentation.