The IRS released Notice 2025-42 on Friday, August 15,  in response to an Executive Order issued on July 7 directing the Secretary of the Treasury 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.” Notice 2025-42 makes “the Five Percent Safe Harbor provided under [previous] IRS notices is not available” for the purpose of determining when construction has begun. Notice 2025-42 takes effect until September 2, 2025. However, the Five Percent Safe Harbor remains available for those projects with a capacity of 1.5 megawatts or less.

As a result, the Physical Work Test is the only means by which the beginning of construction date may be established in order to qualify for the section 48E investment credit and the Section 45Y production credit under the Inflation Reduction Act of 2022 (the “IRA”). Accordingly, only when “physical work of a significant nature” (with respect to the section 48E investment credit) or significant energy production (in the case of production tax credits under section 45Y) has occurred will construction be deemed to have begun. In addition to removing the Five Percent Safe Harbor, Notice 2025-42 indicates the IRS will be taking a more aggressive position in examining if projects have met the beginning of construction timelines necessary to qualify for credits under sections 45Y and 48E following the enactment of the One Big Beautiful Bill Act (the “OBBBA”) on July 4, 2025 and the accelerated phase out of many tax credits implemented by the IRA. The OBBBA cut off section 45E and 45Y credit eligibility for projects beginning construction after July 4, 2026 or placed in service after 2027 (the “Placed-in-Service Deadline”).

These deadlines replaced the original phase out schedule of 2032 or when U.S. greenhouse emissions dropped to specified levels set by the IRA. In accordance with the new rules instituted by the OBBBA, the credits allowed under sections 45Y and 48E will no longer be allowed for solar or wind facilities placed in service after the Placed-in-Service Deadline. However, the Placed-in-Service Deadline only applies to projects that begin construction after July 4, 2026, i.e., 12 months following the enactment of the OBBBA. Projects on which construction began prior to the Placed-in-Service Deadline need not be placed in service prior to the Placed-in-Service Deadline, but must still meet the requirements for continuous progress from the beginning of construction date to the date the property is placed in service.

While the removal of the Five Percent Safe Harbor is a significant change, the requirements of the Physical Work Test remain effectively unchanged. Construction will be considered to have begun when physical work of a significant nature has begun, provided there is no break in “a continuous program of construction” (the “Continuity Requirements”).

For the purposes of the Continuity Requirement, delays due to such issues as weather, natural disasters, supply and labor shortages, or permitting continue to be disregarded. Additionally, the four-year safe harbor for satisfying the Continuity Requirement is available under Notice 2025-20, which deems solar or wind facilities placed into service within four years of beginning construction to have met the Continuity Requirement, is available.

Notably, the Five Percent Safe Harbor remains available for facilities with “low output solar facility.” For the purposes of Notice 2025-42, a “low output solar facility” is any solar facility with a “maximum net output of not greater than 1.5 megawatt[s],” which is measured at the facility level. As a result, developers of rooftop, parking cover, or other smaller systems can still make use of either the Five Percent Safe Harbor or the Physical Work Test, giving them much more flexibility than developers of larger facilities.

Further guidance is expected on the restrictions under the OBBBA disallowing incentives for clean energy projects with ties to entities or individuals with business ties to foreign governments that the United States government considers adversarial, including China, Russia, North Korea, and Iran (foreign entities of concern, or FEOC).  The July 7 executive order directed the Treasury to issue guidance by August 18 to implement the enhanced FEOC restrictions. 

If you have any questions about the application of the Notice or the OBBBA  to your business or personal tax situation, please contact Wells Hall, Maurice Holloway, Tim Wagner, Amanda Wilson, Martin Gitlin, Jim Reardon, Seth Proctor, Alexis Rallis or any other member of the Nelson Mullins Tax and Energy Environmental and Projects practice groups.