IRS Section 48: The Energy Investment Tax Credit

The Investment Tax Credit (ITC) under Internal Revenue Code Section 48 is a federal incentive for businesses and individuals that invest in clean energy projects. Its purpose is to lower the initial expenses of these investments, encouraging a faster transition to renewable energy. The Inflation Reduction Act of 2022 (IRA) substantially altered the credit by revising the amounts, expanding the list of qualifying technologies, and introducing new labor standards that project owners must meet to receive the full incentive.

Qualifying Energy Properties

To be eligible for the Section 48 credit, an investment must be in a specific type of “energy property.” Solar energy property, which converts sunlight into electricity, remains a primary qualifying technology. Geothermal equipment, which harnesses heat from within the earth, also qualifies for the credit. The IRA expanded this definition to include a broader range of modern technologies.

The list of eligible properties now explicitly includes:

• Energy storage technology, such as batteries, with a capacity of at least five kilowatt-hours
• Qualified fuel cells, which generate electricity through a chemical reaction, and microturbine properties
• Combined heat and power (CHP) systems that produce both electricity and useful thermal energy from a single fuel source
• Qualified small wind energy properties
• Qualified biogas property, which involves systems that convert biomass into methane
• Microgrid controllers for managing and isolating independent power grids

This expansion ensures that the tax incentive structure keeps pace with technological advancements in the renewable energy sector, covering not just generation but also storage and management systems.

Calculating the Credit Amount

The calculation of the Section 48 credit follows a two-tiered structure that links the credit amount to specific labor practices. The base credit is 6% of the eligible cost basis of the energy property placed in service during the tax year. However, the credit can be increased to a full rate of 30% if the project meets certain requirements.

To qualify for the 30% rate, energy projects with a maximum net output of one megawatt or more must satisfy both prevailing wage and apprenticeship (PWA) requirements. Projects under this one-megawatt threshold are exempt from the PWA rules and can claim the 30% credit without meeting them.

On top of the 30% rate, projects can earn additional “bonus” credits. A 10% bonus is available for projects that meet domestic content requirements, meaning a specified percentage of materials are produced in the United States. Another 10% bonus is available for projects located in designated “energy communities,” such as areas with a history of fossil fuel employment. A project meeting PWA, domestic content, and energy community requirements could stack these credits to achieve a 50% total credit.

Prevailing Wage and Apprenticeship Requirements

The prevailing wage component requires that all laborers and mechanics involved in the construction, alteration, or repair of the facility are paid wages at or above local prevailing rates as determined by the Department of Labor. These rates are specific to the geographic area and the type of work being performed.

The apprenticeship requirement mandates that a percentage of total labor hours are performed by qualified apprentices from a registered apprenticeship program. This percentage is 12.5% for projects that began construction in 2023 and rises to 15% for those starting in 2024 or later. Projects must also adhere to specific apprentice-to-journeyworker ratios as established by the Department of Labor or applicable state agencies.

Taxpayers must maintain records to demonstrate compliance, including payroll for all laborers and mechanics, proof of apprentice registration, and evidence of meeting labor hour percentages. The IRS has a “good faith effort” exception for the apprenticeship rules. A taxpayer can cure a failure by making corrective payments to underpaid workers and paying a penalty to the IRS to still qualify for the enhanced credit.

Claiming the Investment Tax Credit

Before filing, a taxpayer must collect all necessary documentation. This includes detailed records of the property’s cost basis and the exact date the property was “placed in service,” meaning it was ready and available for its intended function.

The credit itself is claimed by completing and filing IRS Form 3468, Investment Credit. This form is where the taxpayer formally calculates the credit amount based on the project’s cost basis and the applicable credit rate.

Once Form 3468 is accurately filled out, the form must be submitted with the taxpayer’s annual federal income tax return. For an individual, this would be Form 1040, while a corporation would attach it to its Form 1120. The completed form becomes part of the overall tax return package, and the calculated credit is used to offset the taxpayer’s federal tax liability.

Monetization Options for the Credit

The Inflation Reduction Act introduced two methods for monetizing the Section 48 credit, making the incentive more accessible. These options address the issue where developers, particularly those without significant tax liability, could not fully utilize the credits they generated.

The first option is transferability, which allows for-profit entities to sell their tax credits to an unrelated taxpayer for cash. This creates a direct market for the credits, enabling a developer to receive an immediate cash infusion from a corporation that has a large tax bill it wants to reduce. The sale is a one-time transfer, and the cash received by the seller is not considered taxable income.

The second option, known as direct pay, is designed for specific tax-exempt entities. This includes non-profits, state and local governments, Indian tribal governments, and rural electric cooperatives. Since these organizations have little to no federal income tax liability, a tax credit would be of little use. Direct pay allows them to treat the credit amount as an overpayment of tax, resulting in a direct cash refund from the IRS, which effectively turns the tax credit into a direct grant.