President Biden signed the Inflation Reduction Act (IRA) into law on August 16, 2022. While we all await regulatory guidance from agencies charged with implementing the IRA, one thing is abundantly clear: the IRA provides substantial funds to tax-exempt organizations and political subdivisions interested in converting their electricity usage to green energy. In fact, the IRA allocated $369 billion dollars over the next 10 years to fund energy and climate projects in an attempt to reduce emissions by approximately 40% by 2030. One of the most innovative aspects of the IRA involves its creation of a direct-payment methodology that is available, in lieu of providing a non-refundable credit, to entities who do not traditionally file tax returns. Through a series of articles over the coming weeks, we will address various aspects of the IRA and provide our insights on how we’ve already seen this new law impacting our clients.
Direct payments authorized under the Inflation Reduction Act - §6417
The direct payment provisions of the IRA are codified in IRC §6417. This section provides an ability for eligible entities to receive direct cash payments from the federal government in lieu of income tax credits that would likely be of little use. Entities eligible for direct payments include tax-exempt entities, states and their political subdivisions, the Tennessee Valley Authority, Indian Tribal governments, Alaska Native Corporations, and corporations that operate on a cooperative basis to engage in furnishing electric energy to people in rural areas. Thus, this list would include 501(c)(3) organizations like hospitals and private colleges, 501(c)(4) social welfare organizations, and 501(c)(6) trade associations. It would further include cities, counties, public school districts, public universities, and other similar entities.
Two of the most important types of tax credits that are eligible to be received via direct payments are the investment tax credits (ITC) and production tax credits (PTC). The IRA expanded these credits to assist with financing renewable energy projects while also encouraging tax-exempt entities to retain ownership of the projects. The PTC was extended to include, among others, facilities that generate electricity as a result of wind, solar, biomass and geothermal projects that begin construction before January 1, 2025. The ITC was expanded to include things like small wind, solar, microgrid controller and energy storage system projects that begin construction before January 1, 2025.
The ITC is a singular credit that can be taken after an energy project is completed and placed into service. The amount of ITC for eligible energy projects begins at a base value of 6% of the costs of a project after the energy system is placed into service. That amount can be increased to 30% of the costs if certain prevailing wage and registered apprenticeship requirements are satisfied. On November 30, 2022, the U.S. published its initial guidance regarding these prevailing wage and apprenticeship requirements.
The PTC is a tax credit that is received over a 10-year period. The PTC is credited on a yearly basis according to standards set forth by the IRS. As opposed to using the upfront invested costs of an energy project to calculate the eligible amount of credit like the ITC, the PTC is based upon the amount of energy that is produced each year by an energy project. The baseline value of the PTC varies due to inflation each year, but it generally increases. In 2022, the PTC had a base rate of $0.005/kWh. However, the PTC for projects that met the prevailing wage and apprenticeship requirements had a base rate of $0.026/kWh. Just like with the ITC, by meeting certain prevailing wage and apprenticeship requirements, the base rate of the PTC increases to 5x its initial amount.
An election of direct payment pursuant to §6417 can only be made at such time and in such manner as the Secretary of the Treasury may provide. Direct payments of credits are able to be obtained by filing a tax return that requests a refund amount that is calculated off of the amount of a project’s eligible ITC or PTC.
The actual amounts of direct payment equal the full amount of eligible credit if a project satisfies the domestic content requirement, has a maximum output of less than one megawatt or construction of the project begins on or before December 31, 2023. The amount of credit available to be received via direct payment for projects that do not meet those criteria equates to only 90% of a project’s eligible credit if construction begins in 2024 and 85% if construction begins in 2025. In order to receive any direct payment for projects that begin construction in 2026 and beyond, the domestic content requirements must be satisfied.
Finally, the IRA also created a manner for which entities that are not tax-exempt can engage in a one-time transfer of certain tax credits to an unrelated taxpayer in exchange for cash via IRC §6418. It is important to note that entities who are eligible for direct payments under §6417 are not eligible to transfer their credits for cash.
Conclusion
In the next article we will address several state and local tax issues our clients have encountered when developing a solar project financed in part by direct-pay credits.
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