On June 6, 2026, the U.S. District Court for the District of Columbia (court), in Oregon Environmental Council v. IRS, vacated IRS Notice 2025-42 and remanded it to the IRS. The court found that the IRS failed to engage in reasoned decision-making when it eliminated the long-standing 5% safe harbor for determining when construction begins on wind and solar projects, as required for IRC Sections 45Y credits (clean energy production) and 48E credits (clean electricity investment).

Background

The "One Big Beautiful Bill Act" (OBBBA) eliminated the IRC Section 45Y and 48E credits for wind and solar projects placed in service after December 31, 2027, except for projects for which construction begins within 12 months of July 4, 2025 (see Tax Alert 2025-1434).

Previously, taxpayers could show construction began by either: (1) starting "physical work of a significant nature" (the physical work test), or (2) paying or incurring at least 5% of the facility's total cost (the 5% safe harbor test). In addition, they had to demonstrate continuous construction or continuous efforts (the continuity requirement).

Following enactment of the OBBBA and an executive order directing stricter enforcement of credit-termination rules, the IRS issued Notice 2025-42, which generally eliminated the 5% safe harbor for wind and large-scale solar projects and limited taxpayers to the physical work test as the primary method of establishing the beginning of construction (see Tax Alert 2025-1709).

The lawsuit was filed by a group of governmental and private organizations that argued that Notice 2025-42 would harm them by making electricity more expensive, increasing air pollution and disrupting the development of projects in which they had economic interests.

Court analysis and decision

The plaintiffs argued that the Administrative Procedure Act (APA) requires the Notice to be set aside, as it is arbitrary and capricious. In support of that argument, the plaintiffs noted that (1) the IRS failed to articulate a reasoned basis for the major policy change reflected in the Notice; (2) the Notice arbitrarily singled out wind and certain solar projects for disfavored treatment without justification; and (3) the IRS failed to consider serious reliance interests or evaluate alternative policy options when adopting the Notice.

The court explained that agencies must engage in reasoned decision-making under the APA. When changing long-standing guidance or practices, an agency must consider the reliance interests created by its previous policy and provide a reasoned explanation for any shift.

The court found that Notice 2025-42 was arbitrary and capricious, stating that:

• Eliminating the 5% safe harbor was a major change in how the IRS defined "beginning of construction" for clean energy tax credits.
• This change implicated serious reliance interests, which the IRS itself had encouraged by repeatedly reaffirming its prior approach.
• The IRS did not adequately justify its decision to change course.

The court highlighted that the 5% safe harbor had been consistently recognized for over a decade, influencing taxpayer investment decisions and creating significant reliance interests that needed careful consideration before any policy change.

The court vacated the Notice in full and remanded it to the IRS for further consideration. The court noted that "[u]nfortunately, significant uncertainty will exist no matter how this Court resolves this case and what remedy it awards."

Implications

The court ruling brings the 5% safe harbor option back to the table, providing project developers with two options for establishing beginning of construction for their projects. Taxpayers that have been unable to establish beginning of construction under the physical work test due to permitting or other reasons could consider the 5% safe harbor option but would need to weigh the risk of the IRS issuing revised guidance or the government successfully appealing the court ruling. Additionally, some taxpayers could consider establishing beginning of construction under the 5% safe harbor as a way to manage risk around the physical work test.

Given the short window between the court holding and the July 4, 2026 deadline, taxpayers may want to consider the feasibility of meeting all the requirements for the 5% safe harbor option and consult with their advisors, as this is a developing topic.