Tax Blog/Blawg

In the One, Big, Beautiful Bill Act (“OBBBA”), Congress accelerated the termination of the clean electricity production credit provided in Section 45Y and the clean electricity investment credit under Section 48E.  On July 7, 2025, President Trump issued Executive Order 14315 in which he instructed the Secretary of the Treasury to issue guidance related to the termination of the clean electricity credits to prevent the artificial acceleration or manipulation of the eligibility requirements and restrict the use of safe harbors to only situations in which a substantial portion of a facility has been built.  On August 15, 2025, the Internal Revenue Service followed the President’s directive and issued Notice 2025-42[1] providing additional guidance related to the beginning of construction requirements for purposes of terminating the Section 45Y and 48E credits. 

The Service significantly limited a taxpayer’s ability to satisfy the beginning of construction requirement by removing, with one exception for low output solar facilities, the five-percent safe harbor.  For any taxpayer who wishes to use the previous Five Percent Safe Harbor – which is more broadly available to the clean electricity industry – the taxpayer must satisfy the previous safe harbor’s criteria prior to September 2, 2025, which is the effective date of Notice 2025-42.  However, for any taxpayer who seeks to satisfy the Physical Work Test, Notice 2025-42 left it nearly identical to the pre-OBBBA test.  In the event the taxpayer attempts to satisfy the Physical Work Test in order to show it began construction, the taxpayer must meet its requirements by July 4, 2026.  If a taxpayer fails to satisfy the Physical Work Test by that date, the taxpayer will only have until December 31, 2027 to place the qualified facility in service in order to qualify for either credit under Section 45Y or 48E.

The OBBBA’s termination of the Section 45Y and 48E credits and the new limitations the Service promulgated in Notice 2025-42 create a substantial dilemma for taxpayers with plans to construct a qualified facility and claim either credit.  Does a taxpayer significantly increase investment in a qualified facility within the next handful of days to meet the five-percent safe harbor prior to its near removal on September 2, 2025?  Or does a taxpayer attempt to satisfy the Physical Work Test by July 6, 2026 to avoid the placed in service deadline of December 31, 2027?  Either route poses significant practical and compliance risks.  No matter which route taken, the Service may scrutinize the facts and circumstances surrounding taxpayers who attempt to avoid the September 2, 2025 effective date for the new limited safe harbor or satisfy the Physical Work Test prior to July 6, 2026.  In light of the OBBBA, Executive Order 14315, and Notice 2025-42, taxpayers must proceed with caution when claiming the clean electricity production credit and/or the clean electricity investment credit as these credits may develop into a significant enforcement area in future years.

Background

The clean electricity production credit provided under Section 45Y permits a taxpayer to claim a credit with respect to electricity the taxpayer produced at a qualified facility in two scenarios.  First, the taxpayer sold the electricity to an unrelated party.[2]  Second, the taxpayer sells, consumes, or stores the electricity it produced in a facility equipped with a metering device which is owned or operated by an unrelated party.[3]  The clean electricity investment credit permits a taxpayer to claim a credit with respect to the taxpayer’s qualified investment in any qualified facility.[4]  Both credits define a “qualified facility” as a facility – placed in service after December 31, 2024 – which is used to generate electricity and for which the greenhouse gas emissions rate or the anticipated emissions rate is not greater than zero.[5]

OBBBA terminates the clean electricity production credit and clean energy investment credit for any applicable wind facility or solar facility placed in service after December 31, 2027.[6]  However, the OBBBA credit termination date only applies if a taxpayer begins construction of a qualified facility after July 4, 2026.[7]  Long before OBBBA, the IRS published guidance to assist taxpayers in determining when a taxpayer establishes that he or she begins construction for purposes of Sections 45Y and/or 48E.[8]  This prior guidance established that a taxpayer begins construction by satisfying either the “Physical Work Test” or the “Five Percent Safe Harbor”.[9]

In response to Executive Order 14315, the IRS issued Notice 2025-42 which fundamentally altered the prior guidance as it relates to the beginning of construction deadline.  That Notice retained the Physical Work Test but limited the availability of the Five Percent Save Harbor to a single exception.

Physical Work Test

Notice 2025-42 retains the original framework of the Physical Work Test as a taxpayer meets the “beginning of construction” requirement when physical work of a significant nature begins.  Either the taxpayer or a third-party may conduct this work.  However, if the third party performs this work on behalf of the taxpayer, then the taxpayer and the third party must enter into a binding written contract prior to the manufacture, construction, or production of the qualified facility for the taxpayer’s use in his or her trade of business.  The Physical Work Test focuses on the nature of the work performed, rather than the amount of work or its financial cost.  To that end, the Notice does not establish a construction completion percentage or monetary threshold that a taxpayer must meet. 

Additionally, the Physical Work Test does not limit the physical work of a significant nature to work performed at the site of the qualified facility.  Off-site physical work, on-site physical work, or a combination of the two may satisfy the test.  Off-site physical work that may satisfy the test includes manufacture of components, support structures, inverters, transformers, and other power conditioning equipment.  In essence, the type of off-site physical work that may qualify involves the manufacturing, constructing, or producing of components or equipment that assists the qualified facility in the production of clean electricity. 

The Notice provides a non-exhaustive list of on-site physical work of a significant nature.  In the case of an applicable wind facility, the Notice establishes that physical work of a significant nature begins with the excavation of the foundation, the setting of anchor bolts into the ground, or the pouring of the concrete pads of the foundation.  Also, if the wind turbines are being assembled on site using components a third-party manufactures off site and then delivers to the site, then physical work of a significant nature begins at the off-site location if: (1) the third party manufacturer’s work is done pursuant to a binding written contract; and (2) the components are not held in the manufacturer’s inventory.  Failing either step will cause the physical work of a significant nature to begin when the taxpayer starts to assemble the wind turbine on site.  For an applicable solar facility, on-site physical work of a significant nature may include the installation of racks or other structures to affix photovoltaic panels, collectors, or solar cells.

(a) Non-qualifying activities

The Physical Work Test does not include the following activities: (1) preliminary activities; or (2) work to produce a component or part of a qualified facility that is either in existing inventory or normally held in inventory by one selling the component/part to a taxpayer.  Preliminary activities include planning or designing the qualified facility, securing financing for the facility, exploring, researching, conducting mapping and modeling to assess a resource, obtaining permits and licenses, conducting geophysical, gravity, magnetic, seismic, and resistivity surveys, conducting environmental and engineering studies, clearing a site, conducting test drilling to determine soil condition, excavating to change the contour of the land (however, excavation for a foundation is not a preliminary activity), and renovating existing foundations, turbines, towers, solar panels, or any components that will no longer be part of the qualified facility.  The manufacture, production, or construction of components or parts held in existing inventory – or normally held in inventory – by one selling the component or part to the taxpayer also do not qualify as physical work of a significant nature.

 (b) The Continuity Requirement

The Physical Work Test further requires that the taxpayer maintain a continuous program of construction with respect to the qualified facility.  A disruption of the continuous program will be excused only when the disruption is beyond the taxpayer’s control.  Excusable disruptions include delays due to severe weather conditions, delays due to natural disasters; delays in obtaining permits or licenses from federal, state, local, or Indian tribal governments; delays at the written request of a federal, state, local, or Indian tribal government regarding matters of public safety, security, or similar concerns; interconnection-related delays, such as those relating to the completion of construction on a new transmission or distribution line or necessary transmission or distribution upgrades to resolve grid congestion issues; delays in the manufacture of custom components; delays due to labor stoppages; delays due to inability to obtain specialized equipment of limited availability; delays due to the presence of endangered species; financing delays; and delays due to supply shortages.  Interestingly, financing delays qualify as an excusable disruption in physical work of a significant nature, while securing financing is a preliminary activity that does not qualify as physical work of a significant nature.

However, the continuity requirement contains a safe harbor that allows the construction of a qualified facility to satisfy the requirement if it is placed in service no more than four calendar years after the calendar year in which construction began.

Five Percent Safe Harbor for Low Output Solar Facilities

 The sole safe harbor the Notice provides to satisfy the beginning construction requirement is in the case of a low output solar facility.[10]  A low output solar facility is a qualified facility that has maximum net output of not greater than 1.5 megawatt, which is measured at the level of the qualified facility.  The property included in the low output solar facility includes all functionally interdependent components of property that can operate apart from other property to produce electricity.  It also includes property owned by the taxpayer that is an integral part of the qualified facility.

For purposes of the Notice, the maximum net output of the qualified facility is the nameplate generating capacity.  The nameplate generating capacity is measured independently from any other applicable solar facility that shares an integral part with the qualified facility.  However, if two applicable solar facilities have integrated operations, then the integrated operations are measured in aggregate for purposes of the 1.5-Megawatt Maximum.  The nameplate capacity is the maximum electrical generating output in megawatts that the unit of qualified facility is capable of producing on a steady state basis and during continuous operation under standard conditions, as measured by the manufacturer and consistent with the definition of nameplate capacity provided in 40 C.F.R. § 96.202.

^{[1] https://www.irs.gov/pub/irs-drop/n-25-42.pdf.}

^{[2] I.R.C. § 45Y(a).}

^{[3] Id.}

^{[4] I.R.C. § 48E(a).}

^{[5] I.R.C. § 45Y(b)(1)(A); I.R.C. § 48E(b)(3)(A).}

^{[6] Pub. L. No. 119-21, § 70512(a), 139 Stat. 252 (2025);  Pub. L. No. 119-21, § 70513(a), 139 Stat. 270 (2025).}

^{[7] Pub. L. No. 119-21, § 70512(l)(4), 139 Stat. 270 (2025);  Pub. L. No. 119-21, § 70513(g), 139 Stat. 273 (2025).}

^{[8] See Notice 2013-29, 2013-20 I.R.B. 1085; Notice 2017-04, 2017-4 I.R.B. 541; Notice 2018-59, 2018-28 I.R.B. 196; Notice 2020-41, 2020-25 I.R.B. 954; Notice 2021-41, 2021-29 I.R.B. 17; Notice 2022-61, 2022-52 I.R.B. 560.}

^{[9] Id.}

^{[10] The existence of the safe harbor does not bar a taxpayer that is placing a low output solar facility into service from satisfying the physical work test.}