The Inflation Reduction Act (IRA) initially introduced new domestic content rules that apply to a variety of clean energy tax credits. Such rules encourage the use of domestically produced materials by providing bonus credit amounts to taxpayers who otherwise qualify for the relevant investment tax credit or the production tax credit. The eligibility requirements for this credit are intricate, hinging on a product’s type and its place of origin. The complexity is heightened by regulations pertaining to components and phaseout rules. Further complicating matters are recent developments and changes applied to several energy tax credits through the One, Big, Beautiful Bill (OBBB). However, enhanced tax credits still await those who successfully navigate domestic content qualifications.
A primer on domestic content
Congress has historically favored the use of domestic materials and products for particular purposes. Examples span decades, beginning with the Buy American Act of 1933. Subsequent infrastructure legislation in 1982 included the Buy America Act. More recently, the Infrastructure Investment and Jobs Act, enacted in 2021, enhanced the domestic content preference for infrastructure projects by including the Build American Buy American Act in the final bill. The domestic content rules noted above apply to specific situations, typically federal procurement of federally funded projects. The IRA took the next step in 2022 by extending those rules to taxpayers undertaking credit-eligible projects.
Domestic content rules often indicate a preference for domestically produced materials and equipment rather than an absolute requirement. The inclusion of exceptions is important in situations where domestic production is either unable to meet demand or to do so within reasonable cost parameters. However, the IRA went further on this front by also creating the Section 45X Advanced Manufacturing Production Credit, which incentivizes the domestic production of green energy components. The expectation is that an increase in the available supply of domestic components will result in a corresponding increase in satisfaction of the domestic content requirement discussed below. Finally, although this article focuses specifically on the domestic content requirements, recently enacted changes via the OBBB further magnify the issue through the inclusion of foreign entity of concern rules. Such rules may penalize projects that receive materials from certain foreign countries.
Who can benefit from the domestic content bonus credit?
The domestic content bonus credit is available to taxpayers who certify their qualified facility or project was constructed with certain percentages of steel, iron, or manufactured products that were mined, produced, or manufactured in the United States. Such bonus is applicable to both the investment tax credit (ITC), under Sections 48 and 48E, and the production tax credit (PTC), under Sections 45 and 45Y. Those credits relate to the production of electricity from renewable resources, storage of electrical and thermal energy, as well as the adoption of other favored technologies. The relevant ITC and PTC rules have different effective dates but generally apply to projects placed in service after Dec. 31, 2021, and for which construction begins by Dec. 31, 2032.
Satisfaction of the domestic content requirement will increase the ITC by an additional 10% of the basis of the eligible property. This would increase the credit percentage from 30 to 40% (assuming the project otherwise qualifies for the 30% credit). Alternatively, the domestic content bonus for the PTC is a 10% increase in the calculated credit amount.
As outlined in IRS Notice 2023-38, the domestic content bonus credit is a two-tiered incentive designed to bolster the use of American-made materials. First, taxpayers must certify that their qualified facility, energy project, or energy storage technology incorporates a certain percentage of steel, iron, or manufactured products mined, produced, or manufactured within the United States. Subsequently, to fulfill the second step and secure the bonus credit, they must demonstrate that the credit is not subject to phaseout.
Domestic content eligibility criteria for steel or iron
For a qualified project to be eligible for this bonus amount, 100% of all manufacturing processes related to any applicable steel and iron project components must occur within the United States. Wind turbines are ideal examples of these projects, as the construction of such projects heavily relies on steel and iron components. The domestic manufacturing requirement doesn’t apply to the metallurgical processes used for refining steel additives, or to steel or iron products that are used in the components or subcomponents of a manufactured product. The Internal Revenue Service (IRS) has provided a list of subcomponents that are exempt from this regulation, including nuts, bolts, and screws. Although these items are primarily made of steel or iron, they aren’t considered structural in function. For instance, a steel bolt used in the assembly of an engine wouldn’t be subject to the domestic manufacturing requirement, as it’s not a structural component of the project. This distinction allows for greater flexibility in sourcing materials for taxpayers.
Domestic content eligibility criteria for manufactured products
Manufactured products are the result of deliberate processes — ones that reshape raw materials, altering them with new functions and enhancing their value. The result is something that represents “a new item functionally different from that which would result from mere assembly of the elements or materials.” Battery packs, inverters, and generators are all excellent examples of what the IRS considers to be manufactured products in this context.
For manufactured products to qualify for this bonus, all manufactured projects’ components must be, or must be deemed to be, manufactured in the United States. A manufactured product component is, “[A]ny article, material, or supply, whether manufactured or unmanufactured, that is directly incorporated into an applicable project component that is a manufactured product.” The cell packaging, thermal management system, and battery management system within a battery all serve as representative project components. A project component is considered produced in the United States if all of the manufacturing processes for the component take place in the United States, and all of the manufactured product’s components are of U.S. origin. A manufactured product component is deemed to be of U.S. origin if it’s produced within the United States, irrespective of the origins of its subcomponents.
Adjusted percentage rule for the domestic content bonus credit
Products, such as solar panels, may have components that are largely sourced in the United States, but are not entirely of U.S. origin. The domestic content bonus credit doesn’t outright reject the eligibility of this product. When a manufactured product is made using components that are of mixed origin, the product may still qualify as manufactured in the United States if the adjusted percentage rule is satisfied.
After the passage of the OBBB, the key percentage to keep in mind depends on technology type and when a project begins construction. This adjusted percentage rule is met when the domestic cost percentage for an applicable project equals or exceeds the specified adjusted percentage. For example:
- Projects that began construction before June 16, 2025, generally require an adjusted percentage of 40%.
- Projects beginning construction anytime during the remainder of the 2025 calendar year must meet a 45% threshold (27.5% for offshore wind).
- Projects beginning in 2026 must meet a 50% threshold (35% for offshore wind).
- Projects beginning in 2027 (including offshore wind) or later must meet a 55% threshold.
The domestic cost percentage comes from dividing the domestic-manufactured products and components cost by the total manufactured products cost. The domestic-manufactured products and components cost includes both the costs of U.S.-manufactured products that serve as applicable project components, as well as costs of manufactured product components from non-U.S.-manufactured products, but only if those components are mined, produced, or manufactured in the United States.
When calculating the domestic manufactured products and components cost for an applicable project, taxpayers and applicable entities consider only the direct costs associated with U. S.-manufactured products or U.S. components. These direct costs include direct materials and direct labor expenses incurred by the U.S.-manufactured product’s manufacturer or by the non-U.S.-manufactured product’s manufacturer for producing the U. S. component. However, the domestic-manufactured products and components cost excludes direct materials or direct labor costs incurred by the non-U.S.-manufactured product’s manufacturer for producing the non-U.S.-manufactured product.
Additionally, the costs of incorporating the applicable project components into the project aren’t included in the domestic-manufactured products and components cost. The total manufactured products cost for an applicable project is the aggregate of costs associated with each applicable project component that qualifies as a manufactured product. When determining this cost, taxpayers and applicable entities consider only the direct costs, which include direct materials and direct labor expenses. These costs must be paid or incurred within the meaning of Section 461 by the manufacturer responsible for producing the manufactured product.
Retrofitted property
Projects that have been retrofitted qualify for the domestic content bonus, provided that the project complies with the 80/20 rule. For any retrofitted projects, the value of the used property included in the project must account for 20% or less of the total value of the relevant project. This rule is in place to encourage new investments in green energy, while limiting, but not prohibiting, the use of old projects.
Domestic content safe harbor
Since the enactment of the IRA, the domestic content bonus has been a common pain point for many taxpayers looking to claim investment or production tax credits. This is mostly due to challenges in sourcing domestically produced components for renewable energy. While the expectation is that such components will be produced at increased levels domestically over the coming years, the current availability of the domestic content bonus credit may seem like a long shot position for some projects. Causing additional headache is the need to request and produce information from vendors and subcontractors on cost and production information that those parties may be reluctant to share.
In May 2024, to the delight of many, the IRS issued Notice 2024-41, which was meant to solve the commercial problem created by using direct costs to figure the adjusted percentages for manufactured products. Notice 2024-41’s solution comes in the form of a new elective safe harbor. Those taxpayers who elect into the new safe harbor must use a table (contained in the Notice), in lieu of calculating the adjusted percentage according to the method described in Notice 2023-38. The table provides both cost percentages and classifications for common components used in a variety of projects. While the IRS will accept the tabled percentages and classifications instead of actual cost information, taxpayers and applicable entities must apply the table in its entirety. As such, taxpayers and applicable entities who elect into the safe harbor must use the table as “the exclusive and exhaustive set” of components. While the table provided does include helpful information for common projects such as wind, solar, and battery storage projects, other technologies are not yet included on the list. Furthermore, a taxpayer may find that the included information on the table may not be as advantageous to their fact pattern in comparison to actual project cost and information. For that reason, taxpayers may need to complete a cost benefit analysis when determining if the safe harbor is actually the preferred path.
To better examine the safe harbor, consider this example. Assume a 100-megawatt photovoltaic (PV) tracker consists of five categories of components: (1) PV modules; (2) inverters; (3) PV trackers; (4) steel piles; and (5) steel rebar.
- As to component (1), there are two sets of modules: one is manufactured in the United States and has a 60-MW capacity; the other isn’t manufactured in the United States and has a 40-MW capacity.
- As to component (2), none of the inverters are manufactured in the United States; none have U.S. components.
- As to component (3), there are seven categories of components manufactured in the United States, except for one, torque tubes; domestically manufactured torque tubes are directly integrated with 80-MW of PV modules.
- As to components (4) and (5), these are manufactured in the United States and, per the table, meet the steel or iron requirement.
The table shows that as to (1), the manufactured components are 54.8% of the total cost, and the cost to produce the modules is 11.5% of the project cost. The sum of these percentages is multiplied by 60% because only the 60 MW set is manufactured domestically. The table shows that as to (3), torque tubes are 9.7%, and this percentage must be multiplied by 80% because torque tubes are only integrated with 80MW of the project.
The basic adjusted percentage rule is:
- (domestic manufactured products and components cost) / (total manufactured products cost) ≥ 40%.
Once weighted averages are applied to (1) and (3), the values are summed as follows:
- (54.8% + 11.5%) x .6 = 39.8% | 9.7% x .8 = 7.8% | 39.8% + 7.8% = 47.6%.
Because 47.6% is at least 40%, the project satisfies the adjusted percentage rule.
Domestic content credit phaseout and elective pay elections
As one might imagine, the complexity of the domestic content analysis can be significant. The analysis can be so significant that a taxpayer may determine that it’s not worth the effort of proving domestic content and therefore simply not claim the bonus. Complicating matters further is the fact that entities that choose to make an elective pay election might face a decrease in the credit amount, known as a credit “phaseout.” Therefore, applicable entities who make an elective payment election whose qualified facility or energy project fails to meet the domestic content requirement will receive a percentage reduction in the total amount of their otherwise eligible project.
Under the phaseout rule, an applicable entity making an elective pay election for the ITC will receive 100% of its eligible credit if: the property satisfies the domestic content requirements described in Notice 2023-38 (as described above in the domestic content bonus section), or the maximum output of the project is less than one megawatt (or 3.4mmBtu/hr for biogas and other technologies), or construction began before Jan. 1, 2024. If none of these requirements are met, the original amount of the bonus credit will be reduced to 90% for projects that begin construction in 2024, 85% for projects that begin construction in 2025, and 0% for projects that begin construction Jan. 1, 2026, or later. As such, the failure to meet domestic content requirements can be a fatal mistake, especially as we head toward 2026. However, some exceptions do exist. In cases where neither of these apply, eligibility can be established via the following exceptions:
- Increased cost exception: The inclusion of steel/iron or manufactured products produced in the United States would increase the cost of construction by more than 25%.
- Nonavailability exception: Relevant steel/iron or manufactured products aren’t produced in the United States in the sufficient and reasonably available quantities or satisfactory quality.
What to do now regarding the domestic content bonus credit
Despite the evolving landscape of energy tax credits, lucrative opportunities still exist for clean energy projects, especially those that utilize domestic materials. While the eligibility criteria are complex, substantial tax credits are available for those who meet these qualifications. Eligible taxpayers stand to not only gain a reduction in tax liability, but also the ability to transfer credits to other entities. Potential purchasers of credits are likely to evaluate the project records of any taxpayers looking to transfer credits. For this reason, to maximize these benefits, meticulous planning and adherence to the stipulations are essential. Without detailed records of the components and subcomponents used in eligible projects, those seeking to take advantage of these credits could find themselves unable to substantiate their claims. To be prepared and to take advantage of the domestic content bonus credit amounts, taxpayers need to start planning well before actual construction begins on their applicable projects.
