U.S. District Court Vacates IRS Notice 2025-42, Reinstating Five Percent Safe Harbor for Clean Energy Projects

WASHINGTON D.C. – The U.S. District Court for the District of Columbia on June 6, 2026, issued a landmark ruling vacating IRS Notice 2025-42, a controversial directive that had eliminated the Five Percent Safe Harbor method for establishing "beginning of construction" for certain wind and large-scale solar energy projects. This decision effectively reinstates a critical pathway for developers to qualify for federal clean energy tax credits under Internal Revenue Code Sections 45Y and 48E.

Prior to the now-vacated Notice 2025-42, the Internal Revenue Service (IRS) had, since 2013, recognized two primary methods for taxpayers to demonstrate that construction on an energy project had begun for federal income tax purposes. These were the Physical Work Test, which required starting physical work of a significant nature, and the Five Percent Safe Harbor, which allowed projects to qualify by paying or incurring at least five percent of the total facility cost. Both methods had been consistently reaffirmed by the IRS through various notices over more than a decade, creating a stable framework for clean energy investment.

However, in August 2025, following an Executive Order aimed at curtailing clean energy incentives, the IRS issued Notice 2025-42. This notice significantly narrowed eligibility for tax credits by eliminating the Five Percent Safe Harbor for all wind projects and solar projects exceeding 1.5 megawatts (AC). Under this new guidance, these larger projects were left with the Physical Work Test as their sole means to establish the beginning of construction and safe harbor against credit termination deadlines. Notably, other clean energy sources like nuclear, geothermal, and hydropower were not subjected to these new restrictions, raising concerns about disparate treatment within the clean energy sector.

The court's decision, issued in the case Oregon Environmental Council v. IRS, No. CV-25-4400, found Notice 2025-42 to be "arbitrary and capricious" under the Administrative Procedure Act (APA). The ruling highlighted that the IRS failed to provide a reasoned basis for its abrupt policy shift. Specifically, the court noted that the agency offered only a cursory justification for eliminating the Five Percent Safe Harbor, neglecting to meaningfully explain its concerns about potential circumvention or manipulation of eligibility. Furthermore, the court emphasized that the IRS failed to adequately consider the "serious reliance interests" of industry participants who had structured their project financing and development timelines based on the long-standing availability of the Five Percent Safe Harbor.

The impact of Notice 2025-42 had been immediate and substantial for many developers. For instance, Hopi Utilities Corporation (HUC), a plaintiff in the lawsuit, had an 8-megawatt solar project that would have qualified for federal clean energy investment tax credits under the Five Percent Safe Harbor. Due to the notice, HUC had to rearrange its plans and incur significant additional expenses to attempt to qualify under the Physical Work Test, demonstrating the real-world financial pressures imposed by the IRS's policy change. Woven Energy LLC, a consulting firm assisting Tribes with energy infrastructure, also reported that multiple clients intended to use the Five Percent Safe Harbor for their wind and solar projects and faced similar disruptions.

The lawsuit challenging the IRS notice was brought by a coalition of environmental and public interest groups, along with affected entities. Plaintiffs included the Oregon Environmental Council, Natural Resources Defense Council (NRDC), Public Citizen, Hopi Utilities Corporation, Woven Energy, the City and County of San Francisco, and the Maryland Office of People’s Counsel.

The court's full vacatur of Notice 2025-42 means that the Five Percent Safe Harbor is once again a viable option for wind and large-scale solar projects to establish their beginning of construction for federal tax credit eligibility. This provides a renewed sense of certainty for developers and investors in the clean energy sector, allowing them to revert to planning methods that were relied upon for over a decade.

This ruling is a significant development for businesses engaged in the clean energy sector, particularly those involved in developing wind and large solar facilities. In our experience, navigating the complexities of tax credits and eligibility requirements can be a major hurdle for project financing and overall business strategy. The sudden removal of a long-standing safe harbor created considerable uncertainty and financial strain for many, forcing them to re-evaluate project viability and incur unforeseen costs. The court's decision to reinstate the Five Percent Safe Harbor offers a more predictable environment, which is crucial for long-term capital investment in renewable energy. We often see clients struggle with understanding the nuances of these changes and how they impact their bottom line, making expert guidance in areas like tax preparation and compliance invaluable. Businesses looking to understand the implications of this ruling for their specific projects and ensure compliance with federal tax guidelines should contact C&S Finance Group LLC at csfinancegroup.com to explore how we can assist.

As the IRS considers its next steps following this legal setback, the clean energy industry will closely monitor for any new guidance or administrative actions. While the Five Percent Safe Harbor is restored for now, the agency could potentially issue new rules in the future, albeit with the requirement to provide a more robust and reasoned justification that addresses reliance interests and adheres to administrative law principles.