Executive Summary
The Inflation Reduction Act (IRA) of 2022 introduced transformative incentives for clean energy investments, including the Investment Tax Credit (ITC) under Sections 48 and 48E of the Internal Revenue Code. A key feature is the elective payment option, commonly known as “direct pay,” which allows certain entities—such as tax-exempt organizations, governments, and tribal entities—to receive cash payments from the IRS equivalent to the credit amount, rather than offsetting tax liability. However, for projects electing direct pay, failure to meet domestic content requirements can trigger “haircut” provisions, reducing the payable amount. These reductions apply to larger projects and phase in over time, incentivizing the use of U.S.-manufactured materials.
This white paper explores the haircut provisions, their application to specific technologies like geothermal, solar, battery storage, and thermal storage, and exemptions such as the 1 MW threshold. It draws on IRS guidance, including Notices 2023-38, 2024-9, 2024-41, 2024-84, and 2025-08, to provide actionable insights for developers, investors, and stakeholders in the clean energy sector.
Introduction
The Section 48 Energy Credit provides an ITC for investments in qualifying energy property, such as renewable generation and storage systems. Starting in 2025, Section 48E introduces a technology-neutral Clean Electricity ITC, extending similar benefits to zero-emission electricity facilities placed in service after 2024. Both credits can reach up to 30% of qualified costs or even higher with bonuses for prevailing wage, apprenticeship, energy communities, and domestic content compliance, making them pivotal for accelerating the energy transition.
Under Section 6417, “applicable entities” such as tax-exempt organizations, state and local governments, Indian tribal governments, Alaska Native Corporations, the Tennessee Valley Authority, and rural electric cooperatives can elect direct pay for these credits. This mechanism treats the credit as an overpayment of tax, refundable as cash. However, to promote domestic manufacturing, the IRA imposes domestic content requirements for direct pay elections on projects of 1 MW or greater. Non-compliance results in a haircut—a percentage reduction in the payment amount—unless an exemption or exception applies.
These provisions balance incentives for clean energy deployment with economic goals, such as job creation in U.S. supply chains. As of 2026, with ongoing IRS updates and legislative tweaks, understanding these rules is essential for project viability.
Overview of Domestic Content Requirements
Domestic content rules under Sections 48 and 48E align with Buy America standards, adapted for energy projects. They consist of two main components:
- Steel or Iron Requirement: All structural steel or iron components (e.g., foundations, racking, piles) must be 100% manufactured in the U.S., with all manufacturing processes (except metallurgical refinement) occurring domestically. This does not apply to non-structural items like bolts or fittings.
- Manufactured Products Requirement: Manufactured products must meet an “adjusted percentage” of domestic content, calculated based on direct costs. The threshold starts at 40% for most projects beginning construction in 2023-2024 (20% for offshore wind), increasing to 45% in 2025, 50% in 2026, and 55% thereafter. Safe harbors in IRS Notices provide elective classifications and assigned cost percentages for common components, simplifying compliance.
Projects must certify compliance via attestation and maintain records. Separate but related is the domestic content bonus credit (up to 10% adder), available regardless of direct pay election if requirements are met. For direct pay, however, meeting these standards is mandatory to avoid haircuts on the base and bonus credits.
The Haircut Provisions: When and How They Apply
The haircut provisions, outlined in Sections 45(b)(10), 45Y(g)(12), 48(a)(16), and 48E(d)(5), reduce the elective payment for non-compliant projects. They apply only to applicable entities electing direct pay and kick in for projects beginning construction after 2023 that do not meet domestic content requirements.
| Construction Begin Year | Applicable Percentage (if Non-Compliant) |
|---|---|
| Before 2024 | 100% (No Haircut) |
| 2024 | 90% |
| 2025 | 85% |
| 2026 and Later | 0% |
The reduction multiplies the full credit amount by the applicable percentage. For example, a 2024 project qualifying for a $10 million ITC would receive only $9 million in direct pay if domestic content is not met. By 2026, non-compliant projects receive nothing via direct pay, effectively barring applicable entities from monetizing the credit without compliance or an exception.
These rules do not apply to taxable entities claiming the credit against tax liability—only to direct pay elections. The 2025 One Big Beautiful Bill Act did not modify these percentages for Sections 48 and 48E, though it introduced separate haircuts for other credits like Section 45Z.
Applicable Technologies
The haircut provisions apply to all energy properties eligible for the ITC under Sections 48 and 48E when direct pay is elected. Below is an analysis for some specific technologies:
- Solar: Fully covered under Section 48. Components like modules, trackers, inverters, and racking are subject to domestic content rules. Utility-scale solar projects greater than 1 MW face haircuts if non-compliant. Section 48E extends this to post-2024 zero-emission solar facilities.
- Geothermal: Eligible under Section 48 for electric generation and heat pumps. Structural elements and manufactured products must meet requirements. Geothermal projects often exceed 1 MW, making haircuts a key risk for direct pay. Section 48E applies to post-2024 clean geothermal electric generation investments.
- Battery Storage: Qualifies as energy storage technology under Section 48(c)(6), including grid-scale batteries. Key components include battery packs, cells, management systems, and housings. Haircuts apply to >1 MW projects electing direct pay. Section 48E covers similar post-2024 installations.
- Thermal Storage: Included within energy storage under Section 48(c)(6), encompassing systems that store thermal energy for later use (e.g., molten salt or ice storage). Components like storage tanks and heat transfer fluids are evaluated for domestic content. As with batteries, >1 MW projects risk haircuts. Section 48E applies to qualifying clean thermal storage.
All these technologies can qualify for the domestic content bonus if requirements are met, but for direct pay, compliance avoids haircuts. IRS safe harbors (e.g., Notice 2025-08) classify components for solar and battery storage explicitly; geothermal and thermal may require case-by-case analysis using actual costs or updated elective safe harbors.
Exemptions and Exceptions
Several safeguards prevent overly punitive application:
- 1 MW Exemption: Projects with a maximum net output of less than 1 MW measured in alternating current are exempt from domestic content requirements for full direct pay. This applies at the facility level. It supports smaller-scale deployments, such as community solar or distributed storage, without compliance burdens. Note: This differs from the prevailing wage/apprenticeship 1 MW exemption, which applies broadly but aligns in scope.
- Increased Cost Exception: If using U.S.-produced steel, iron, or manufactured products increases overall project costs by more than 25%, the requirement is waived. Attestation and recordkeeping suffice until further IRS guidance (extended through at least 2026 per Notice 2024-84).
- Non-Availability Exception: Waiver if qualifying items are not produced in the U.S. in sufficient quantities or satisfactory quality. Similar attestation rules apply.
These exceptions must be claimed via IRS procedures, with transitional relief for projects beginning before 2027. Projects under 1 MW or qualifying for exceptions receive 100% payment regardless of construction year.
Implications for Project Developers and Stakeholders
For applicable entities pursuing direct pay, the haircut provisions underscore the need for supply chain diligence. Sourcing U.S.-made components can secure full payments and bonuses but may increase upfront costs—though exceptions provide flexibility. Technologies like solar and battery storage, with maturing domestic supply chains, are better positioned; geothermal and thermal storage may face challenges due to specialized components.
Developers should:
- Conduct early cost analyses using IRS safe harbors.
- Incorporate domestic content into procurement contracts.
- Monitor IRS updates, as thresholds rise over time.
- Consider alternatives like credit transferability under Section 6418 for taxable partners if direct pay risks are high.
In a post-IRA landscape, these rules drive investment in U.S. manufacturing, potentially lowering long-term costs through economies of scale.
Conclusion
The haircut provisions in Sections 48 and 48E serve as a carrot-and-stick mechanism: rewarding domestic content compliance with full direct pay while penalizing reliance on imports. Applicable to all technologies included in Section 48 and 48E over 1MW including geothermal, solar, battery, and thermal storage projects, they phase in reductions that could eliminate payments by 2026 for non-compliant projects. However, the 1 MW exemption and statutory exceptions ensure accessibility for smaller or constrained initiatives.
As clean energy adoption accelerates, stakeholders must integrate these requirements into planning to maximize IRA benefits. For more tailored advice, consult tax professionals or visit resources like IRS.gov for the latest guidance.
This white paper is provided for informational purposes by Walker Blue and does not constitute legal or tax advice. Last updated January 2026.
