IRS issues guidance on "elective payment" option for renewable energy and other qualifying projects
The Inflation Reduction Act of 2022 ("IRA"), which was signed into law on August 16, 2022, authorizes new federal spending to reduce carbon emissions, including significant tax incentives for clean energy. The new tax incentives expand existing federal tax credits for solar energy and other renewable energy projects and add new credits intended to expand the clean energy economy. For the first time, tax-exempt and governmental organizations are able to directly benefit from some of these tax incentives. The IRS recently issued guidance on many provisions of the IRA, including those that apply to tax-exempt and governmental entities.
Historically, tax credits for clean energy projects have only been available to taxpayers with tax liability. As a result, many charities and other nonprofits have been unable to take full advantage of clean energy tax incentives. The "elective payment" (often called "direct pay") provisions of the IRA allow qualifying tax-exempt and governmental entities to receive a payment equal to the full value of tax credits available for qualifying clean energy projects. Elective payment works by treating the amount of the credit as a payment of tax. If no tax is in fact due by the electing entity (or the credit exceeds the amount of tax due), the amount of the credit (or the amount of the credit in excess of the tax due) is treated as an overpayment and a refund will be issued.
Eligible Entities and Qualifying Projects
Organizations eligible for elective payment include those exempt from tax by Section 501(a), states and their political subdivisions, agencies and instrumentalities, Indian tribal governments, Alaska Native Corporations, and rural electric cooperatives. Those include all organizations described in Section 501(c), such as public charities, private foundations, social welfare organizations, labor organizations, business leagues, and others. They also include religious or apostolic organizations under Section 501(d) and public universities and hospitals that are agencies and instrumentalities of states or political subdivisions. These types of entities are referred to in the legislation and related guidance each as an "applicable entity."
Proposed Treasury Regulations require the applicable entity to own the underlying property that generates the eligible credit or otherwise conduct the activities giving rise to the credit. The required ownership can occur through direct ownership, ownership through a disregarded entity, or ownership of an undivided interest through a tenancy-in-common arrangement. Notably, the Proposed Treasury Regulations do not permit partners of entities classified as partnerships to use elective payment. Further, elective payment is not available for purchased or transferred credits or credits otherwise not determined directly with respect to the applicable entity.
Applicable Tax Credits
In general, an applicable entity can use elective payment in connection with the following 12 tax credits as long as the entity meets the credit's underlying requirements. This list includes many longstanding clean energy credits, as well as several newly introduced credits.
- Energy Credit (Section 48)
- Clean Electricity Investment Credit (Section 48E)
- Renewable Electricity Production Credit (Section 45)
- Clean Electricity Production Credit (Section 45Y)
- Commercial Clean Vehicle Credit (Section 45W)
- Zero-emission Nuclear Power Production Credit (Section 45U)
- Advanced Manufacturing Production Credit (Section 45X)
- Clean Hydrogen Production Credit (Section 45V)
- Clean Fuel Production Credit (Section 45Z)
- Carbon Oxide Sequestration Credit (Section 45Q)
- Credit for Alternative Fuel Vehicle Refueling / Recharging Property (Section 30C)
- Qualifying Advanced Energy Project Credit (Section 48C)
The amount of some of the applicable credits can vary based on several factors, and certain grants and forgivable loans as well as financing provided by tax-exempt bonds can reduce the amount eligible for direct pay. For example, the base credits available under the energy investment tax credit and electricity production tax credit are multiplied by five if applicable prevailing wage and apprenticeship requirements are satisfied. In addition, bonus credits are available to small solar and wind projects located in low-income communities, projects located in energy communities (brownfields and certain areas previously dependent on fossil fuel industries), and projects that meet certain domestic content requirements. The available bonus credits for projects located in low-income communities will be allocated pursuant to applications submitted on the Department of Energy portal (which is expected to open soon) and must not be placed in service before receiving an allocation.
To take advantage of the new elective payment regime, an applicable entity must fulfill various administrative requirements. First, the applicable entity must register the project on the IRS electronic portal, which is expected to be live by Fall 2023. Upon completing the registration process, the IRS will provide the applicable entity with a registration number for each applicable credit property. The organization will need to provide that registration number on an original, timely filed (including extensions) Form 990-T for the year the tax credit could otherwise be claimed. A Form 3800 (General Business Credit) and any forms required to claim the specific credit must also be filed. Once the Form 990-T is processed, a refund for the deemed payment of tax, to the extent it exceeds any federal income tax liability, will be paid. Note that no elective payment will be made until the due date of the Form 990-T, even if it is filed early, and the election cannot be made on an amended Form 990-T.
The option for elective payment of energy tax credits presents an exciting new funding opportunity for qualifying tax-exempt organizations, and incentivizes increased clean energy development among the nonprofit sector. However, given the complexities of the credit regime generally and the direct ownership requirements specifically, tax-exempt and governmental entities seeking to take advantage of the elective payment opportunities are well advised to seek tax and legal counsel well-versed in the area to ensure they qualify for the underlying tax credits and comply with the elective payment requirements. This complexity is reflected in the concerns expressed in comments received by the IRS on the elective payment regime, many of which requested reduced advance registration requirements, the ability to partner with for-profit entities, the ability to elect direct payment for transferred credits, and accelerated payment timelines.
At DWT, we have robust teams of practitioners with expertise in advising nonprofit organizations in all aspects of governance and tax compliance and with expertise in renewable energy projects, including in this burgeoning area of energy tax credits and elective payment.