Key Takeaways:

  • In an effort to spur investment in renewable energy projects, Congress and the Biden Administration are considering “direct pay” options
  • Direct pay would allow project developers to receive tax refunds regardless of their tax liability and corresponding capacity to utilize tax credits
  • Whether direct pay is an appropriate option in the current economic climate depends on many factors, including the prospect of increased corporate tax rates and an economy set to rebound from COVID-19

Both Congress and the White House have recently proposed “direct pay” options for developers of US renewable energy projects—notably, direct pay proposals are part of President Biden’s $2 trillion American Jobs Plan announced March 31, 2021 and included in the Growing Energy and Efficiency Now Act (Green Act) and section 45Q carbon capture legislation (ACCESS 45Q). If enacted, the direct pay option may be an attractive alternative to traditional tax equity for the monetization of tax credits from renewable energy projects.

Traditionally, renewable energy projects are financed in part through tax equity financing, which brings in investments from financial institutions and profitable corporations with large tax bills that can take advantage of the tax credits generated by such projects to offset their tax liability. However, in a COVID-induced recession, these traditional sources of financing for tax equity may be uncertain about their capacity to use tax credits, making them cautious about the amount of capital to commit to tax equity investments.

Direct pay eliminates the need to find an investor able to utilize tax credits because direct pay is not tied to tax liability. Under the new direct pay proposals, a developer would treat tax credits generated by a renewable energy project, such as the investment tax credit (ITC) or production tax credit (PTC), as equivalent to a payment of tax on the developer’s filed tax return. As a result, the developer would be entitled to receive a tax refund in the amount by which the available direct pay credit exceeds such developer’s tax liability. By contrast to the traditional tax equity structure, under which a taxpayer realizes the value of tax credits only to the extent of such taxpayer’s tax liability, a taxpayer in the direct pay regime would realize the value of tax credits regardless of the amount of tax the taxpayer owes.

The new direct pay proposals feature several important differences from the Section 1603 Cash Grant program created in 2009, which allowed developers of certain renewable energy projects to monetize tax credits by applying for and receiving a cash grant directly from the Treasury. Direct pay does not require Congress to authorize a grant program and appropriate money towards it. Additionally, administering direct pay through the IRS utilizes an existing process, as companies already file tax returns every year.

A direct pay option might incentivize further development of renewable energy projects because it would allow project developers to monetize tax credits without a tax equity investor, enabling them to finance renewable energy projects even when tax equity financing is hard to come by. It also appears to be a hot topic in Washington as evidenced by its mention in the Biden Administration’s American Jobs Plan and congressional legislation. Nonetheless, with the prospect of increased corporate tax rates and additional federal government stimulus on top of the $5 trillion appropriated in the past 12 months alone, the fate of the direct pay avenue and its potential to incentivize renewable energy development remains unclear.