December, 9th 2024
DISCLAIMER: This information does not replace legal advice from a professional tax/financial planner or the Internal Revenue Service (IRS).
In 2022, the Inflation Reduction Act (IRA) made the single largest investment in a new clean energy economy. Part of the IRA is a package of clean energy tax credits, and for the first time, non-taxpayers such as states, local governments and nonprofits are able to access those tax credits through a system called elective or direct pay. In this blog, we will explain what direct pay means (while trying to not sound like a tax accountant), tell you which clean energy projects are eligible for direct pay, and point you toward useful resources and services that will help get your direct pay application started.
What Is Direct Pay?
The IRA includes new and expanded tax credits that support the investment in clean energy technologies, clean manufacturing and clean vehicles. Tax-paying entities were historically the only ones that could claim clean energy tax credits. Through a new provision called elective or direct pay, local governments and other tax-exempt organizations now also have the potential to benefit by filing a tax return with the Internal Revenue Service (IRS) to receive cash payments that equal the value of those tax credits.
Note that direct pay is noncompetitive and uncapped, meaning that tax-exempt entities are guaranteed to receive a cash payment from the IRS as long as their energy project is eligible and they file for their tax credit correctly and on time. Depending on the nature of the energy project and where it is located, those tax credits can cover as much as 70 percent of the project cost.
What Clean Energy Tax Credits Qualify?
Elective or direct pay makes 12 IRA clean energy tax credits (see list here) available to organizations and governmental entities that don’t pay taxes. Those 12 tax credits cover investments in manufacturing, clean vehicles, clean fuel production, clean energy generation, and carbon capture. Among those, tax credits for clean energy generation and clean vehicles represent the most applicable opportunities for many tax-exempt organizations and local governments to tap into.
For instance, the Investment Tax Credit (ITC) (§ 48 and 48E of the tax code) provides a credit for investments in renewable energy projects, such as solar, small wind, energy storage, fuel cells, microgrid controllers, and combined heat and power properties. The ITC allows for a one-time tax credit for the tax year the energy project is installed and starts running. As an example, a local government installs and connects rooftop-solar to the electric grid on government-owned housing in October 2024 and files for the tax credit on that investment by May 15, 2025. The Production Tax Credit (PTC) (§ 45 and 45Y of the tax code) provides a tax credit on renewable energy projects similar to the ITC. In contrast to the ITC though, the tax credit isn’t provided on the investment of the energy project, but on the kilowatt-hour (kWh) for electricity generated for the first 10 years the system is in operation. An asset owner may claim either the ITC or the PTC for the same project, but cannot claim both types of credits. In general, the direct pay claimant, such as a local government or other non-taxable organizations must own the energy project to be eligible for the Investment or Production Tax Credit. Further information about the ITC and the PTC in particular for solar energy systems can be found here.
Tax credits for electric vehicles and plug-in hybrid electric vehicles are also available for local governments and other tax-exempt organizations. Under the Tax Credit for Qualified Commercial Clean Vehicles (§48W of the tax code) direct pay claimants are eligible to receive a cash payment of up to 15% of cost for plug-in hybrids and of up to 30% of cost for electric vehicles. Qualifying clean vehicles include passenger vehicles, buses, ambulances, and certain other vehicles for use on public streets, roads, and highways. Besides the tax credit for commercial clean vehicles itself, direct pay also allows non-taxpayers to claim a tax credit for fueling and charging property for clean vehicles when such stations are located in low-income and rural areas. Under the Alternative Fuel Vehicle Fueling and Recharging Property Credit (§30C of the tax code), qualified fuels include electricity, ethanol, natural gas, hydrogen, and biodiesel.
Who Is Eligible for Direct Pay?
Many tax-exempt entities are eligible for direct pay, including:
- Nonprofit 501(c)(3), 501(d), and 501(a) organizations,
- State, local, and territorial governments,
- Rural electric cooperatives
- Water districts, school districts, and economic development agencies,
- Public universities and hospitals
How to Apply for Direct Pay?
Several steps need to be taken before a local government or other non-tax-paying organizations can apply for cash payments from the IRS through direct pay. First, potential tax-exempt entities need to check that they are eligible and that their energy project is eligible for direct pay. The organization Lawyers for Good Government developed the Clean Energy Tax Navigator which is a great resource to determine direct pay eligibility for different kinds of energy projects (commercial clean vehicles and fleet; electric vehicle charging infrastructure; solar, wind, or geothermal energy projects). Besides eligibility, the Navigator helps answer a host of questions around clean energy tax credits and how to apply for them. It also offers technical assistance, and in certain cases, direct pro-bono services.
To be eligible for direct pay, governmental and other tax-exempt entities need to register with the IRS before their tax return is due. The IRS will request information about the clean energy project, the credit you’re applying for, and your organization to complete the pre-registration process. Consider registering several months in advance of when tax returns are due to assure the registration goes through in time. Once a registration number is provided by the IRS, select elective payment on the IRS form and file your tax return by the deadline. Direct payment occurs once the tax return is processed by the IRS. Thus, you will receive a cash payment from the IRS only several months after the energy project has been purchased and installed. If you are a governmental or non-governmental tax-exempt entity with an energy project that qualifies for one of the 12 IRA clean energy tax credits, you can register for direct pay with the IRS here.
More Resources about Direct Pay
Lawyers for Good Government provides excellent information on their Elective Pay & IRA Tax Incentives Resources Page. The page is regularly updated and offers a wealth of information from recorded webinars that explain what direct pay is, to resources that help you with the filing process with the IRS. It truly is a one-stop-shop for help with direct pay. The Internal Revenue Service (IRS) also has several web resources that provide useful information about elective or direct pay. A good place to start is the IRS’s elective pay and transferability page. Lastly, ReImagine Appalachia hosted a webinar with Amy Turner, Director of the Cities Climate Law Initiative at Columbia’s Sabin Center diving into the nuts and bolts of direct pay. You can watch her presentation here.