The Investment Tax Credit is a great way for businesses to grow, save money, and increase the efficiency of their operations. Unfortunately, this tax credit isn’t the simplest or easiest to claim. One mistake, even an accidental one, can lead to an unexpected tax bill, penalties, and interest.
If you’re considering claiming this tax benefit for your business, understand that the IRS may give your tax return a second look to ensure you’ve claimed it properly. The goal of this article is to explain why this is so, as well as discuss some of the common mistakes business taxpayers make when taking advantage of this tax credit.
Key Takeaways
- Investment Tax Credit (ITC) – 30% (or more) tax credit for the cost of a business’s renewable energy projects.
- Most popular eligible projects – wind, solar, energy storage, and geothermal.
- Inflation Reduction Act of 2022 – made significant changes to the ITC, increasing its popularity.
- Increasing scrutiny – IRS expected to increase audits of returns with ITC claims.
- Problems with ITC audits – claiming the credit before the project is finished, inflating project costs, and improperly claiming credit bonuses.
How the Investment Tax Credit Works
The Investment Tax Credit (ITC) can be found under Section 48 of the Internal Revenue Code. Expanded upon by the Inflation Reduction Act (IRA) of 2022, the ITC provides eligible businesses with a tax credit when they invest in qualified projects, typically in renewable energy and building improvements that increase energy efficiency.
Tax Credit Amount
The size of this tax credit can vary depending on the type of green energy source and when the construction takes place. That being said, most eligible taxpayers receive a 26% to 30% baseline credit on the cost of their clean energy installations when they are put into service.
Bonus credits are possible, further increasing the tax savings. For example, a 10% bonus is available if the construction project meets domestic manufacturing or prevailing wage requirements.
Basic Eligibility Requirements
Most business entities can qualify, including small businesses and large corporations. Nonprofit organizations usually aren’t eligible, although some special exceptions or arrangements may be possible. The primary eligibility requirement revolves around the type of energy project, not the business form. The following list represents commonly eligible green energy projects:
- Solar
- Biogas
- Wind
- Geothermal
- Hydrogen fuel cell
- Energy storage
Ways the ITC Can Be Misused or Improperly Claimed
Many conditions need to be met before claiming the ITC, although many of these revolve around project eligibility. However, even if a taxpayer is eligible for the ITC, there are still several ways in which they could run into problems.
- Project timing: When the project is “placed in service,” is typically when the business can claim the tax credit. The starting date of the project can also affect the size of the tax credit.
- Misstated project costs: The amount of the ITC is based on the project’s costs. This creates an incentive for businesses to overstate the total cost of their projects. This can be done in several ways, such as including non-eligible project expenses or inflating eligible expenses.
- Bonus credits: A business might assert that the project meets the requisite conditions for bonuses even if that’s not the case. Alternatively, the business might be entitled to the bonus, but fail to possess sufficient paperwork to prove eligibility.
- Business use misclassification: The ITC is designed for green energy projects used by businesses, although some individuals still try to claim a personal clean energy project on their business tax return.
- Double dipping: Unless provided for otherwise, a business can’t use the same energy project for multiple clean energy tax credits. For instance, a business taxpayer may be unable to claim the ITC along with the Production Tax Credit (PTC).
Why the IRS Often Audits Tax Returns Claiming the ITC
Taxpayers can claim so many tax credits, so why would the IRS focus on the ITC? Several factors may increase the IRS’ focus on the ITC over other business tax credits.
First, the ITC can be highly lucrative. Renewable energy projects can be costly, and obtaining a 30 %+ tax credit can lead to large tax savings for the business. This not only motivates some businesses to commit tax fraud (or it at least tempts businesses to push the limits of tax avoidance), but it can also give the IRS a bigger return on the resources it spends on audits.
Second, the ITC is complicated. The more complex a tax return is, the more likely tax law mistakes or misinterpretations can occur.
Third, many changes to the ITC came with the IRA around 2022. Many IRS audits don’t focus on the immediately preceding tax year, but instead a few years prior. With many ITCs being claimed after the enactment of the IRA, the IRS will likely increase the number of ITC audits in 2025 and the next few years.
What the IRS Often Looks at During an ITC Audit
Each ITC audit will be unique, but if you get audited, there are common focus areas for IRS revenue agents assigned to these audits. Some of these include:
- Project records: This helps determine when a project began and when it became operational.
- Cost documentation: The auditor will want to confirm the project’s cost and whether any non-eligible expenses were included.
- Bonus credit eligibility: The IRS will look for documents that substantiate the relevant bonus credit, such as where the project is located, where materials were sourced, and how much project workers were paid.
- Contracts: To identify situations where multiple businesses might try to claim the same ITC, the IRS will check any applicable leases or power purchase agreements to make sure neither business improperly claimed the ITC.
- Other tax documents: The auditor will cross-reference values from business tax returns, such as deductible expenses, to ensure they coincide with the numbers provided with the ITC paperwork.
How to Handle a Mistakenly Claimed Investment Tax Credit
If you think there’s a chance you made a mistake with a clean energy credit, there are a few things you can start doing now, before you receive an audit letter from the IRS:
- Begin gathering all documents relating to the ITC: This may include collecting project invoices, receipts, labor certifications, and worker contracts.
- Review the documents you gathered: Check to see if these documents support the amount and eligibility of your ITC.
- Watch out for IRS soft notices: These are letters (such as IRS Letter 5035) that the IRS may send you asking for additional information about your ITC.
- Update your previously filed tax return: If you find a problem, you might be able to fix it before an audit by filing an amended return.
- Voluntarily disclose the error: If someone intentionally claimed the ITC improperly, criminal penalties are possible. Coming forward to disclose this finding before the IRS begins an audit voluntarily may reduce the chances of criminal charges.
- Talk to a tax attorney: If you find a potential problem with your ITC, the best thing to do is schedule a consultation with a tax professional. By doing this, you can get a better understanding of the scope of your problem and what consequences your business potentially faces.
Investment Tax Credit FAQs
What happens if the IRS says I shouldn’t have claimed the ITC?
Assuming you made an honest or reasonable mistake, you can expect the IRS to disallow the credit. This will probably result in an unpaid tax balance, along with audit penalties and interest. If you intentionally gave wrong information to the IRS, you could face the possibility of civil or criminal tax fraud charges.
Can I claim the ITC before my energy system is operational?
Not usually, as the IRS normally requires the project to be completed before a business can claim the ITC. However, if the project begins by a certain date, it may secure the business’s ability to claim the ITC for that project.
What documents will I need for the ITC audit?
The answer to this question depends on the nature of your project, but you’ll basically want any document relating to the project, such as invoices, energy production summaries, compensation records, and compliance paperwork.
Can I file an amended return to fix my ITC claim?
It’s likely possible for your businesses to file an amended return to fix errors before an IRS audit. If you believe the mistake was due to fraud, then understand that an amended return won’t necessarily negate the fraud. In cases where taxpayers willfully file an incorrect tax return, they should not amend but should generally make a voluntary disclosure. Talk with a tax attorney if you’re in this situation.
What should I do if the IRS sent me a letter about my ITC claim?
The best course of action is to consult a tax professional, such as an attorney, with experience handling ITCs. They can explain your best course of action and how to avoid further financial and legal consequences.
Wiggam Law Can Help You With Your Investment Tax Credit
The IRS is expected to begin ramping up its tax audits of deductions and credits introduced or enhanced by the Inflation Reduction Act (IRA) of 2022, including the ITC and other green energy credits. If you’ve already been contacted by the IRS or just want a second opinion, the tax professionals from Wiggam Law can help. To schedule a consultation, call us at (404) 233-9800 or use our online consultation form.