Key Takeaways
- President Donald Trump signed wide-ranging tax legislation, P.L. 119-21 (the Legislation) on July 4. The Legislation will affect nearly every sector of the economy and every type of taxpayer.
- We previously published, on July 8, a comprehensive alert providing a summary and analysis of the Legislation.
- In this alert, which is part of an eight-part series taking a deeper dive into various portions of the Legislation (International Tax; Tax Credits and Opportunity Zones; Estate Planning and Individual Taxes; Renewable Energy Credits; Start-up Investors and Business Owners; Employer-Related and Executive Compensation; Health Care; and Exempt Organizations), we explain and analyze the implications of the Renewable Energy Credit provisions of the Legislation.
There is a possibility of one or more additional reconciliation bills during late 2025 and 2026 and therefore further opportunities for enactment of additional provisions, as well as changes and improvements to the Legislation. And the importance of engaging with the IRS and Treasury as they develop guidance to implement some of the more complex provisions cannot be overstated.
Modifications to Renewable Energy Provisions of the Inflation Reduction Act
The Legislation significantly modifies and in some instances repeals various renewable energy credits and provisions that were enacted as part of the Inflation Reduction Act (IRA). These changes generated enormous amounts of revenue that were integral to help offset some of the Legislation’s deficit-generating provisions. The modifications include the adoption of “prohibited foreign entity” rules that prevent certain entities that either are owned or have commercial ties with persons from covered nations (i.e., China, North Korea, Russia and Iran) from claiming renewable energy credits contained in the IRA. The modifications also include the adoption of “material assistance” rules that prevent eligibility for certain credits where a prohibited foreign entity materially assisted with manufacturing or construction. What follows is an analysis of the most significant changes, along with a description of an executive order issued by Trump on July 7 intended to help provide reassurance to certain House members concerned about the continuing cost to the federal government of various credits and reaction by certain senators to that executive order.
Overview of Prohibited Foreign Entities and Material Assistance
The prohibited foreign entity rules are the culmination of prior legislative attempts to restrict and prevent certain foreign-owned or -controlled entities from benefiting from U.S. federal income tax credits. In many respects, however, the enacted rules go beyond prior attempts by targeting not just certain foreign-owned entities but also commercial transactions and ties with certain foreign-owned companies. The rules broadly apply to renewable energy credits in three situations.
The first situation relates to “specified foreign entities,” which is generally defined as entities that are related to or controlled (through stock or equity) by the government, companies or individuals of covered nations (as defined above).
The second situation relates to “foreign-influenced entities” and targets ownership (similar to the definition of “specified foreign entities”) and commercial transactions and relationships with a prohibited foreign entity. The definition generally causes an entity to be considered a foreign-influenced entity (and in turn a prohibited foreign entity) if a separate prohibited foreign entity has the ability to direct or exercise “effective control” over matters affecting management or operations of the entity. Whether an entity is a foreign-influenced entity is subjective and requires an analysis of the entity’s capital structure (debt and equity), supplier agreements for materials or manufactured goods, and other arrangements such as licensing agreements. The entity’s contracts and other arrangements must be analyzed to determine whether a prohibited foreign entity has the ability to exercise “effective control” over aspects of the entity’s management or operations.
The final situation involves whether an entity receives “material assistance” from a prohibited foreign entity. If an entity does receive material assistance, either the products it makes will not qualify as eligible components under Section 45X or the facility that is being constructed will not be considered a qualified facility for purposes of production and investment tax credits.
The Legislation adopted material assistance rules that analyze cost ratio thresholds for manufactured products and facilities. The cost ratio is calculated based on the total direct material costs paid or incurred by the manufacturer of an eligible component or developer of a facility to a prohibited foreign entity over the total amount of direct costs paid or incurred. If the ratio is above a statutorily defined threshold, the manufactured product or the facility are ineligible for certain renewable energy credits. The Legislation defines the relevant cost ratios and states that until additional guidance is issued, taxpayers may rely on existing IRS guidance relating to domestic content.
The prohibited foreign entity rules take effect in the taxable year beginning after the enactment of the Legislation. The material assistance rules apply to facilities the construction of which begins after Dec. 31, 2025, and to eligible components produced in the taxable year beginning after the date of enactment. Further details relating to these rules are discussed immediately below.
Details Regarding Prohibited Foreign Entity Rules of Section 7701(a)(51)
The Legislation amended Sections 45X, 45Y and 48E to restrict taxpayers that are prohibited foreign entities from claiming credits thereunder.[1] In general, the prohibited foreign entity rules are effective for tax years beginning after July 4, 2025. Section 7701(a)(51)(A)(i) defines a prohibited foreign entity as a specified foreign entity or a foreign-influenced entity.
In 2026, whether an entity is a prohibited foreign entity is determined as of the first day of the taxable year.[2] Thereafter, it is determined as of the last day of a taxpayer’s taxable year.[3]
Definition of ‘Specified Foreign Entity’ and ‘Foreign-Controlled Entity’
“Specified foreign entity” is defined as follows:
- A foreign entity of concern described in subparagraph (A), (B), (D), or (E) of section 9901(8) of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021 (Public Law 116-283, codified at 15 U.S.C. § 4651(8));
- An entity identified as a Chinese military company operating in the United States in accordance with section 1260H of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021 (Public Law 116-283, codified at 10 U.S.C. § 113);
- An entity included on a list required by clause (i), (ii), (iv), or (v) of section 2(d)(2)(B) of Public Law 117-78 (135 Stat. 1527);
- An entity specified under section 154(b) of the National Defense Authorization Act for Fiscal Year 2024 (Public Law 118-31, codified at 10 U.S.C. § 4651); or
- A foreign-controlled entity.
“Foreign-controlled entity” is defined under Section 7701(a)(51)(C) as:
- The government of a covered nation (i.e., the Democratic Republic of North Korea, the People’s Republic of China, the Russian Federation, and the Islamic Republic of Iran);
- An agency or instrumentality of a government of a covered nation;
- A person who is a citizen or national of a covered nation, provided that such person is not an individual who is a citizen or lawful permanent resident of the United States;
- An entity or a qualified business unit (as defined under Section 989 of the Code) incorporated or organized under the laws of, or having its principal place of business in, a covered nation; or
- An entity (including subsidiary entities) controlled by any of the immediately above-mentioned entities or persons.
“Control,” in the case of a corporation, is defined in Section 7701(a)(51)(G) as “ownership (by vote or value) of more than 50 percent of the stock of such corporation.” Similarly, control of a partnership is defined as “ownership (by vote or value) of more than 50 percent of the profits interests or capital interests in the partnership.” For all other situations, “control” is defined as “ownership of more than 50 percent of the beneficial interests in the entity.”
Ownership attribution rules also apply.[4] The first attribution rule is that stock owned directly or indirectly by or for a partnership or estate is considered to be owned proportionately by its partners or beneficiaries. Thus, an individual who owns an interest in a partnership that in turn owns a corporation will be considered to own their proportional share of the interest in the corporation. The second attribution rule provides that stock owned directly or indirectly by or for a trust is considered to be owned by its beneficiaries in proportion to the actual interest of such beneficiaries in the trust. Likewise, stock owned by a trust of which a person is considered the tax owner (i.e., the beneficiary and not the trust is treated for tax purposes as owning the trust’s assets) is considered to be owned by the person who is the tax owner. Finally, a person owning more than 50 percent of the stock (by value) in a corporation is considered to proportionately own stock that the corporation owns in another corporation.
Section 7701(a)(51)(H) does not reference other ownership attribution rules such as (i) instances where an individual is considered to own stock owned by a spouse, child, grandchild or parent (but not a sibling) or (ii) when a shareholder’s ownership of stock in one corporation is attributed to another corporation owned by the shareholder. It is not clear whether future IRS guidance will include these additional attribution rules.
Definition of ‘National’
The term “national” of a covered nation is not specifically defined in Section 7701(a)(51). It has, however, been defined in other areas of the law. For example, under U.S. federal immigration laws, a national is defined as “a person owing permanent allegiance to a state.”[5] Similarly, the Committee on Foreign Investment in the United States (CFIUS) has promulgated regulations providing that a foreign national is “any individual other than a U.S. national” and a U.S. national is “an individual who is a U.S. citizen or an individual who, although not a U.S. citizen, owes permanent allegiance to the United States.”[6] Future IRS guidance will need to provide clarity on the definition of a “national” under Section 7701(a)(51).
Material Assistance and 45X Tax Credits – Section 7701(a)(52)
In addition to the foregoing, the Legislation limits an eligible component (i.e., a solar module or solar cell) from qualifying for credits under Section 45X where the production of the eligible component involved the material assistance of a prohibited foreign entity.[7] Unlike the terms “specified foreign entity” and “foreign-influenced entity,” “material assistance” is not a subjective term. Instead, it is objectively defined based on a cost ratio and statutorily defined threshold percentages.[8] The cost ratio is based on two numbers. The first is the total direct material costs paid or incurred by the taxpayer[9] for the production of the eligible component.[10] The second is the total direct material costs that are paid or incurred by the taxpayer for production of the eligible components that are produced or manufactured by a prohibited foreign entity.[11] The ratio is calculated using the following formula:
(Total Direct Material Costs – Prohibited Foreign Entity Direct Material Costs)
Total Direct Material Costs
A taxpayer may elect to exclude from the cost ratio the direct material costs of components, constituent elements and subcomponents that are (a) acquired by the taxpayer pursuant to a binding written contract entered into prior to June 16, 2025, and (b) used in an eligible component sold before Jan. 1, 2027.[12] For solar components such as solar modules or solar cells, this ratio must be greater than 50 percent for components sold in 2026, 60 percent for components sold in 2027, 70 percent for components sold in 2028, 80 percent for components sold in 2029, and 85 percent thereafter.[13]
We expect the IRS to publish guidance to clarify how taxpayers may determine the amount of material assistance received from a prohibited foreign entity.[14] This guidance will likely define the components, constituent materials and subcomponents that are used to manufacture an eligible component and assign cost percentages to each, thus allowing a taxpayer to calculate the cost ratio solely by reference to the guidance and determination of whether the supplier of the component, constituent material or subcomponent is or is not a prohibited foreign entity. In the interim, taxpayers may rely on certifications from suppliers of manufactured products, constituent elements or subcomponents of an eligible component attesting to the total direct costs of such items that were produced or manufactured by a prohibited foreign entity or attesting that such product or component was not produced or manufactured by a prohibited foreign entity.
To ensure the integrity of this certification process, the tax law provides that suppliers that know or reasonably should know that certifications are inaccurate or false will be subject to a penalty if the false certification results in an understatement of tax due to the denial of a tax credit.[15] The penalty is equal to the lesser of (i) 10 percent of the underpayment or (ii) $5,000.[16] The Legislation also increased the statutory period for assessing deficiencies related to material assistance from three years to six years, and it adopted a new accuracy-related penalty associated with understatements of tax attributable to not meeting the material assistance rules and the resulting disallowance of Sections 45X, 45Y and 48E tax credits.[17]
July 7 Executive Order Regarding Beginning of Construction and FEOC, and Reaction of Certain Senators
Trump issued an executive order on July 7 stating, in Section 3, in relevant part:
“(a) Within 45 days following enactment …, the Secretary of the Treasury shall take all action as the Secretary of the Treasury deems necessary and appropriate to strictly enforce the termination of the clean electricity production and investment tax credits under sections 45Y and 48E of the Internal Revenue Code for wind and solar facilities. This includes issuing new and revised guidance as the Secretary of the Treasury deems appropriate and consistent with applicable law to ensure that policies concerning the “beginning of construction” are not circumvented, including by preventing the artificial acceleration or manipulation of eligibility and by restricting the use of broad safe harbors unless a substantial portion of a subject facility has been built,” and
“(b) Within 45 days following enactment …, the Secretary of the Treasury shall take prompt action as the Secretary of the Treasury deems appropriate and consistent with applicable law to implement the enhanced Foreign Entity of Concern restrictions….”
On Aug. 1, Sen. Chuck Grassley stated in the Congressional Record that he placed a hold on three of the president’s nominees to the Treasury Department, explaining that he wants to ensure that any rules or regulations issued by Treasury in response to the executive order “adhere to the law and congressional intent.” Grassley noted: “What it means for a project to ‘begin construction’ has been well established by Treasury guidance for more than a decade. Moreover, Congress specifically references current Treasury guidance to set that term’s meaning in law. [Both] the law and congressional intent are clear.” Politico reported on Aug. 4 that Sen. John Curtis placed the same hold as Grassley on the same Treasury nominees.
Clean Fuel Production Credit – Section 45Z
The Legislation modifies the clean fuel production credit under Section 45Z to require that feedstocks be produced or grown in the United States, Mexico or Canada. Previously, there were no sourcing requirements with respect to feedstocks, and clean fuel producers were therefore able to import feedstocks such as sugar cane from abroad. The Legislation also contains amendments to the greenhouse gas emissions requirements for land use changes and emissions rates for animal manure used as feedstock. Finally, the Legislation extends the clean fuel production credit to Dec. 31, 2029, which aligns it with the modified phaseout and expiration dates of other credits.
Clean Electricity Production Credit and Investment Tax Credit – Sections 45Y and 48E
The Legislation terminates the clean electricity production credit and the clean electricity investment tax credit for all wind and solar energy property placed in service after Dec. 31, 2027. However, in a last-minute change negotiated by Sens. Grassley, Curtis and others shortly before the Senate’s passage of the Legislation, the termination provision was amended to be effective for property the construction of which begins one year after enactment of the Legislation. Thus, projects that begin construction within the next year are not subject to the Dec. 31, 2027, placed-in-service restriction. This provision generated enormous controversy when the Senate returned the Legislation to the House and may be one of the reasons certain House members concerned about the continuing cost to the federal government of various credits sought assurances from Trump that “beginning of construction” rules would be strictly enforced. It remains to be seen how these rules will be implemented by Treasury and the IRS, including in light of the executive order discussed above. Under that executive order, Treasury and the IRS are expected to issue guidance no later than Aug. 18, 2025.
As noted above, the prohibited foreign entity and material assistance rules apply to all types of facilities eligible for clean electricity production and investment tax credits (biogas, energy storage, geothermal, etc.).
Advanced Manufacturing Production Tax Credit – Section 45X
The Legislation contains revisions to Section 45X, including amendments to the definition of “battery module,” revisions to the rules for integrated components and the ability to stack Section 45X tax credits, and the addition of phaseouts to Section 45X tax credits for the production of critical minerals starting in 2031. The prohibited foreign entity rules also prohibit any manufacturer that meets the definition of “prohibited foreign entity” from claiming a Section 45X credit. The material assistance rules also apply to prohibit any property manufactured with the material assistance of a prohibited foreign entity from qualifying as an eligible component for purposes of Section 45X.
Other IRA Credits
The Legislation repealed the Section 25E credits for previously owned clean vehicles, the Section 30D clean vehicle credit, the Section 45W commercial clean vehicle credit, the Section 30C alternative fuel vehicle refueling property credit, the Section 25C energy-efficient home improvement credit, the Section 25D residential clean energy credit, and the Section 45L new energy-efficient home credit. The repeals have various effective dates: Sept. 30, 2025 (25E credits, 30D credits and 45W credits), Dec. 31, 2025 (25C credits and 25D credits), or June 30, 2026 (30C credits and 45L credits). The Legislation also moved the termination date for Section 45V clean hydrogen production tax credits from Jan. 1, 2033, to Jan. 1, 2028.
Credits for Semiconductor Manufacturers
The legislation increases the advanced manufacturing tax credit, including for semiconductor manufacturers, from 25 percent to 35 percent for certain new facilities.
A summary table of modifications and amendments to renewable energy credits by the legislation:
Conclusion
With the first budget reconciliation bill of this Trump administration enacted, taxpayers should determine the expected impacts and consider adjustments and compliance issues as appropriate.
Some of the proposed changes and spending cuts that were dropped solely because the Senate parliamentarian ruled that inclusion would have violated the Byrd Rule, which governs the reconciliation process, may be revisited during the FY 2026 appropriations process and through stand-alone legislation during the remainder of the 119th Congress. With respect to provisions included in the Legislation, taxpayers should turn their focus toward offering input as Treasury and the IRS develop and issue implementing regulations and related guidance.
One or more additional reconciliation bills are likely during late 2025 and 2026, which presents opportunities for enactment of additional provisions, as well as changes, corrections and improvements to the Legislation. BakerHostetler will continue to assist our clients with advancing their federal policy goals; challenging and, when necessary, litigating IRS enforcement missteps; and keeping our clients and friends updated on federal tax- and budget-related developments.
[1] See P.L. 119-21, Sections 70512, 70514(c)(2).
[2] Section 7701(a)(51)(A)(ii)(II). All references to “Section” herein are to the Internal Revenue Code of 1986, as amended (“Code”).
[3] Section 7701(a)(51)(A)(ii)(I).
[4] Section 7701(a)(51)(H).
[5] 8 U.S.C. Section 1101(a)(21).
[6] 31 C.F.R. Sections 800.223, 800.253; see also 8 U.S.C. Section 1101(a)(22) (defining a national of the United States as a citizen of the United States, or a person who, though not a citizen of the United States, owes permanent allegiance to the United States).
[7] Section 7701(a)(52)(A).
[8] Section 7701(a)(52)(A)(ii).
[9] “Paid or incurred” is defined based on federal income tax principles under Sections 461 and 263A of the Internal Revenue Code.
[10] Section 7701(a)(52)(D)(ii).
[11] Id.
[12] Section 7701(a)(52)(D)(iv).
[13] Section 7701(a)(52)(C)(i)(I).
[14] Section 7701(a)(52)(D)(iii)(I)(cc).
[15] Section 6695B.
[16] Section 6695B(b).
[17] Sections 6501(o), 6662(m).
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