Court Throws Out Notice 2025-42 – 5% Safe Harbor is Back for Wind and Solar

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Why it matters

A federal court has vacated IRS Notice 2025-42, potentially restoring the 5% safe harbor as a valid method for establishing beginning of construction before the July 4, 2026, deadline for wind and solar projects.

What happened

• In August 2025, Treasury issued Notice 2025-42 in response to Executive Order 14315, which generally eliminated the 5% safe harbor test for purposes of the Section 45Y clean energy production credit and Section 48E clean electricity investment credit for wind and solar projects.
• Prior to the Notice, developers could establish beginning of construction either by:
  • Demonstrating physical work of a significant nature; or
  • Paying or incurring at least 5% of total project costs before the applicable deadline.
• The 5% safe harbor framework had been part of IRS guidance for more than a decade.
• The Notice generally made the physical work test the sole qualifying method for wind and solar projects, preserving the 5% safe harbor only for solar facilities of 1.5 MW or less.

The court's reasoning

• The district court found that eliminating the 5% safe harbor implicated "serious reliance interests" because developers had structured projects around the test for years.
• The court concluded that Treasury failed to provide a reasoned explanation for:
  • Treating wind and large-scale solar projects differently from other technologies eligible for technology-neutral tax credits; and
  • Departing from longstanding IRS guidance.
• As a result, the court held that the Notice was arbitrary and capricious, vacated it and remanded the matter to the IRS for further administrative action.

What the ruling means

• If the vacatur is upheld on appeal and the IRS does not further modify the rules on remand, developers may once again establish beginning of construction before the July 4 deadline using either:
  • The physical work test; or
  • The restored 5% safe harbor test.
• The court acknowledged that vacating the Notice could have disruptive consequences as developers race to satisfy the start-of-construction deadline.
• Treasury may appeal the decision, but any appellate ruling—and potentially any revised IRS guidance—is unlikely to occur before July 4.

The uncertainty

• The ruling leaves open several possibilities:
  • The Notice may remain inapplicable;
  • The Notice may be reinstated on appeal; or
  • The IRS may reissue the guidance with a more robust explanation.
• Importantly, the court did not conclude that the IRS lacks authority to restrict the 5% safe harbor. Rather, it held that the agency failed to adequately explain its reasoning and address reliance interests.
• A future notice that provides a more thorough justification could potentially survive judicial review.
• Companies should monitor:
  • Whether Treasury reissues guidance;
  • Whether revised rules apply prospectively or retroactively; and
  • Whether similar changes could eventually extend beyond wind and solar projects.

What developers should consider

• The vacatur creates both opportunity and uncertainty.
• On one hand, restoration of the 5% safe harbor provides an alternative path for projects that may not have completed sufficient physical work.
• On the other hand, the possibility of an appeal or revised IRS guidance creates risk for developers assessing tax credit eligibility.
• Tax equity investors and lenders may require additional protections to address the risk that a project's beginning-of-construction determination could later be challenged.
• We do not expect most developers to pivot to a 5% safe harbor strategy between now and July 4.
• However, developers that have already incurred significant project costs should evaluate whether they may have satisfied the 5% safe harbor as a potential backup to a physical work strategy.

Bottom line

• Companies that may need to rely on the facts-and-circumstances continuous efforts test, rather than the continuity safe harbor, should maintain thorough recordkeeping of:
  • Cost incurrence; and
  • Ongoing development activities.
• Until there is greater clarity from Treasury, the IRS, or the courts, developers should continue preserving flexibility and documenting compliance under both beginning-of-construction pathways.