A Q&A with Sean Moran, Partner; Lauren Collins, Partner; Mary Alexander, Counsel; and Heather Behrend, Counsel at Vinson & Elkins.
August 16 marked the Inflation Reduction Act’s one-year anniversary. Vinson & Elkins partners Sean Moran and Lauren Collins, alongside counsels Mary Alexander and Heather Behrend, share their perspective on the law’s whirlwind first year, the state of play today, and the promising road ahead.
It’s the largest climate legislation in US history, with many complex provisions. But let’s start with the big picture: A year on from the Inflation Reduction Act becoming law, is it living up to its promise?
Sean: Absolutely. From day one, we’ve seen incredible interest in the law’s many generous tax incentives, and interest has only grown since it came into effect. Developers and investors, conventional players and new entrants, small and large taxpayers, established technologies and novel ones — activity has really been across the board.
Lauren: It really has. The law is driving development and investment in clean and renewable energy, and our work has centered on helping clients navigate it to their benefit. Not just us in the tax group, but across much of the firm. Clients are hungry for opportunity in this space, and positioning them to seize it has been an all-hands-on-deck effort.
Let’s dig into one of the law’s headline concepts: monetization — specifically, transferability.
Lauren: This one’s huge. Before the IRA was passed, developers with little or no tax capacity had to rely on tax-equity investors to monetize the credits their projects generate. But now that developers can sell their credits, they can finance their projects without having to enter a conventional tax-equity structure. And on the flip side, more investors who want to enter the industry can do so in a more efficient and palatable manner.
What is the activity looking like?
Heather: Robust so far. Proposed regulations on these transfers just came out in June, but markets have reacted quickly, and deals are moving. These include many purchase-and-sale agreements, where buyers and sellers commit to a transfer even before a project has generated a credit.
Sean: Because of their deep experience analyzing clean and renewable energy projects — and their established relationships with major developers — many traditional tax-equity players have been among the first movers in the transfer market.
Mary: Many new players have jumped in, too — players who might lack renewable-tax expertise, but who have large tax capacity, and see an opportunity to lower their tax bill. These transfers are a win for everyone and make for an exciting market to work in.
But still an evolving one.
Lauren: For sure. Just as with any asset, appetites for tax credits and risk vary widely. So, while we are already seeing market terms develop, a one-size-fits-all approach likely won’t be workable across the board.
Heather: For example, smaller buyers will care about different deal terms, and may require more work getting up to speed on the industry, than big investment banks will. Getting intermediaries into the marketplace — not only to match buyers and sellers, but to verify projects’ eligibility for credits and guide the process — should make the market more liquid and efficient, and lead to more transactions.
About the other major monetization opportunity — direct pay. What are you seeing there?
Sean: It’s definitely another groundbreaking provision. Tax-exempt organizations, governments, Tribes, and other quasi-governmental authorities historically couldn’t capture the benefits associated with tax credits generated by a clean or renewable energy project, because they have no federal tax liability.
Mary: Yes, and with direct pay, these entities can now realize the value of the credits as a cash refund from the IRS. This opens the door for more investment in renewables, and helps expand the reach of clean energy, which is a crucial underpinning of this law.
But Treasury and IRS guidance made it a bit tricky for tax-exempts to qualify.
Lauren: They did. Most tax-exempts come into this space through partnerships, primarily with private equity funds, because they rarely have the expertise to own and operate projects themselves. But partnerships — even those made up entirely of tax-exempts — are ineligible for direct pay.
Mary: There are still viable paths for investment, though. Tax-exempts can generally come in through corporate blockers to participate in a credit transfer, but their return won’t be the full dollar-for-dollar return they would earn with direct pay.
Heather: Tax-exempts can also elect out of partnership treatment for tax purposes, or enter a tenancy-in-common arrangement. But these considerations are complex, and should be navigated carefully.
A few of the credits are carved out from the tax-exempt requirement, correct?
Mary: Correct. For the hydrogen, carbon capture, and advanced manufacturing credits, you don’t have to be tax-exempt to be eligible for direct pay, and activity on this front has been sizable.
Sean: It’s good to see. Compared with more-established technologies, hydrogen and carbon capture have sometimes struggled to attract financing. And the ability to get cash directly from the government, instead of having to rely on investors whose attention may be elsewhere, is incentivizing investment in these newer technologies.
Lauren: On the manufacturing side, developers have of course often looked abroad for the components they need to build. But the carveout is helping stimulate US-based production and sales of manufacturing components, and we’re seeing the impacts of this in real time with clients and counterparties.
Can we dig deeper into the US-based manufacturing? Projects earn a bonus if they meet requirements for US-produced steel, iron, and manufactured products — how are clients reacting to it?
Sean: That’s the domestic content bonus, and the increase in credit value is substantial. So, many developers are working to ensure their projects qualify for it, and much of this work involves the manufactured products requirement.
Heather: Right. For most projects beginning construction before 2025, at least 40 percent of manufactured product costs must come from the United States. The wrinkle is that this applies at the product and component level. If you’re buying, say, a solar panel, you need to know where its components were produced, not just where the panel itself was.
Mary: It’s all about planning. Developers are looking closely at their suppliers’ direct costs, and getting information from them as early as possible, especially for big-ticket purchases. This gives developers a clearer sense of the percentages they’ll need to hit for later purchases — to ensure they reach the 40-percent threshold after accounting for all costs.
Lauren: We do have guidance from Treasury and the IRS on the bonus, but many in the industry have deemed it unworkable. We’ve been helping clients and trade groups respond to the guidance, and hope that it will be revised to give taxpayers greater clarity and relief from the direct-costs requirements.
In the meantime, as Mary noted, we will need to make sure our clients are planning early and often, and, where appropriate, we will still get deals done with the domestic content bonus.
What other key issues are you focusing on with clients?
Heather: One would have to be the wage and apprenticeship requirements. This is a novel concept in the tax and credit world. Essentially, to claim the full value of the tax credits, developers must pay workers at least the prevailing wage for their work — in the area where it’s performed — and ensure that qualified apprentices perform a substantial amount of it.
Mary: Definitely a key issue. These are among the law’s most important provisions — 80 percent of the headline credit value is tied up in them. But satisfying these requirements is not as simple as it sounds, and developers have much to consider around compliance.
Heather: On the wage side, documentation and diligence will be critical — during construction, alteration, and even repair. This includes not just employees, but contractors and subcontractors, too.
What about the apprenticeship side — are there any question marks there?
Sean: Yes, especially involving the good faith effort exception. This allows taxpayers to satisfy the apprenticeship requirements without reaching the threshold for labor hours performed by qualified apprentices. It’s not entirely clear how to go about meeting that exception, though we’re working with clients to develop action plans.
Before we wrap up, let’s look ahead. Clearly, the momentum for clean and renewable energy has never been stronger, but what will determine whether we sustain it?
Heather: For me, legal and regulatory certainty will be key. Treasury and the IRS have done well to fill information gaps. But there’s more work to do, and clarifying the remaining gray areas will spark more development and investment.
Mary: There’s also the economic side to all this. A stronger economy will produce higher tax liabilities, and in turn, a healthier appetite for tax credits. If inflation continues to cool, dealmaking and development should surge, as long as supply chain snarls don’t return.
It really feels like full speed ahead.
Sean: It does. The past year has been a whirlwind of project and structure development, law change, and deal flow. Even though we’ve been working in this area for many years, it seems there’s always something new to learn. It’s a great time to be in clean and renewable energy — and to be a tax lawyer in this space. I can’t wait to see what’s next.