Inflation Reduction Act Credit Monetization Programs Take Shape

There are finally details on the highly anticipated regulations implementing the elective pay and transferability programs for certain renewable energy credits under the Inflation Reduction Act (IRA). These rules create unprecedented opportunities to monetize federal tax credits.

Treasury and the IRS recently released proposed and temporary regulations regarding the new programs. The IRS concurrently posted a number of frequently asked questions on its website. Below are the important details organizations should know.

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What’s in the IRA?

The IRA — the centerpiece of President Biden’s climate agenda — created several new tax credits while expanding others. Many of these credits can be further enhanced if certain requirements are met, increasing an organization’s credit rate by five times or more in some cases.

Much of the excitement around the IRA stems from new programs allowing organizations to monetize their credits through direct cash payments or by selling them to other taxpayers beginning in 2023 — opportunities never seen before at the federal level.

Direct payment opportunities for tax-exempts

Recognizing the vital role that state and local governments, nonprofits, and other nontaxable entities play in advancing renewable energy, the IRA enacted section 6417 to allow these entities to monetize their energy credits through direct cash payments from the federal government (referred to as “elective pay” in the IRA).

Applicable entities are:

• Any organization exempt from federal income tax,
• Any state or political subdivision thereof,
• The Tennessee Valley Authority,
• An Indian tribal government,
• Any Alaska Native Corporation, or
• Any corporation operating on a cooperative basis engaged in furnishing electric energy to persons in rural areas.

The recently issued guidance clarified several questions regarding the definitional scope of an applicable entity.

Which nonprofits are eligible?

Organizations exempt from tax under section 501(a) are eligible for elective pay. This includes all organizations described in section 501(c) (e.g., public charities, private foundations, social welfare organizations, labor organizations, and business leagues). Also included are religious or apostolic organizations under section 501(d).

Which government entities are eligible?

States, their political subdivisions, agencies, and instrumentalities are all eligible for elective pay. This includes cities, counties, and other political subdivisions. Additionally, it includes water districts, school districts, economic development agencies, and public universities and hospitals that are agencies and instrumentalities of a state.

Many welcomed the clarification around public universities due to the statute’s ambiguity on whether such universities could be considered a state instrumentality. Considering the significant role public universities play in furthering green initiatives, being eligible for IRA credits is seen as a major incentive for these institutions.

Which elective pay credits are available?

Only applicable credits may be claimed via an elective payment by tax-exempts. Such credits include:

• Section 30C credit for alternative fuel vehicle refueling/recharging property,
• Section 45 renewable electricity production credit,
• Section 45Q carbon oxide sequestration credit,
• Section 45U zero-emission nuclear power production credit,
• Section 45V clean hydrogen production credit,
• Section 45W commercial clean vehicle credit,
• Section 45X advanced manufacturing production credit,
• Section 45Y clean electricity production credit,
• Section 45Z clean fuel production credit,
• Section 48 energy credit,
• Section 48C qualifying advanced energy project credit, and
• Section 48E clean electricity investment credit.

Direct payment opportunities for taxpaying entities

In addition to the tax-exempt entities listed above, section 6417 allows taxable entities to take advantage of elective pay in connection with certain credits:

• Section 45Q credit for carbon oxide sequestration,
• Section 45V credit for production of clean hydrogen, and
• Section 45X advanced manufacturing production credit.

Many taxpayers are particularly interested in the section 45X advanced manufacturing production credit, which was added to the tax code under the IRA. The credit applies to manufacturing renewable technologies, ranging from wind towers to structural fasteners for solar panels.

What’s the applicable rate for IRA credits?

This depends on the credit claimed as each credit has its own rate and calculation method. Several credits are eligible for a minimum of 6% of an organization’s qualified investment, with potential for a 30% credit (or even higher) if certain conditions are met.

What bonus credits are available?

The IRA enacted several adders, or bonus credits, allowing organizations to increase their base credit rate. The goal of the bonus credits is to encourage U.S. jobs, investments, and manufacturing.

Prevailing wage and apprenticeships

A common theme across the IRA is to encourage projects that pay workers prevailing wage rates (as determined by the Department of Labor) and employ apprentices from registered apprenticeship programs. If these requirements are met, an organization’s credit generally increases by five times from the 6% base rate.

Domestic content

A domestic content (or “made in America”) bonus credit is available for certain production and investment credits, including the credits under sections 45 and 48. It applies to facilities or projects built using the required amounts of domestically produced steel/iron and manufactured products.

When the domestic content requirements are met, production tax credit facilities receive a 10% bonus, and investment tax credit projects receive up to a 10-percentage-point bonus. Starting in 2024, domestic content becomes even more important since applicable credits will be reduced for taxpayers using elective pay if the requirements are not met.

Energy communities

Another bonus credit is available for certain production and investment credits if a project is located in an energy community, including areas with shuttered coal mines or coal-fired power plants. The bonus is also available for brownfield sites and areas with significant employment or local tax revenues from fossil fuels and higher-than-average unemployment. Eligible production credit projects receive a 10% bonus, and eligible investment tax credit projects receive up to a 10-percentage-point bonus.

Low-income communities

An increased credit of 10 or 20 percentage points is available for certain facilities if they are:

• Located in a low-income community,
• Located on Indian tribal land,
• Installed on certain federal housing projects, or
• erve low-income households. 

The IRS released guidance recently outlining the low-income community bonus credit program, including the allocation of environmental justice solar and wind capacity limitations under section 48(e).

How does grant funding affect elective pay?

Since passage of the IRA, tax-exempts have asked how grant funding would impact the receipt of elective payments for investment credit properties as it might be viewed as “double dipping.” Surprisingly, the proposed regulations under section 6417 allow elective payments where grants or forgivable loans are used to purchase or construct the property, with some limitations.

Specifically for purposes of section 6417, the rules provide that tax-exempt income (including income from certain grants and forgivable loans) used to “purchase, construct, reconstruct, erect, or otherwise acquire an applicable credit property described in sections 30C, 45W, 48, 48C, or 48E … are included in basis for purposes of computing the applicable credit amount determined with respect to the applicable credit property, regardless of whether basis is required to be reduced (in whole or in part) by such amounts under general tax principles.”

However, if tax-exempt funding is received for the specific purpose of purchasing, constructing, reconstructing, erecting, or otherwise acquiring an investment credit property and such amount plus the applicable credit otherwise determined with respect to the investment credit property exceeds the cost of the investment credit property, then the amount of the applicable credit must be reduced so the total amount of applicable credit plus the amount of the tax-exempt funding equals the cost of the property.

Example

Assume School District A receives a $400,000 tax-exempt grant from a federal agency to purchase an electric school bus. A purchases the bus for $400,000, which is also A’s basis in the bus. The bus qualifies for the section 45W credit of $40,000. Because the amount of the tax-exempt grant plus the amount of the section 45W credit (total of $440,000) exceeds the cost of the bus, A’s section 45W credit is reduced by the amount necessary so that the total amount of the section 45W credit plus the tax-exempt amount equals the cost of the bus. Therefore, A’s credit is reduced by $40,000 to zero.

Assume instead the grant is $300,000. District A purchases the bus using the grant and $100,000 of A’s unrestricted funds. A’s basis in the bus is $400,000 and A’s section 45W credit is $40,000. Since the amount of the tax-exempt grant plus the amount of the section 45W credit (total of $340,000) is less than the cost of the bus, A’s section 45W credit does not need to be reduced.

Tax-exempt bond financing may require reduction

While it appears bridge or debt financing for a project does not affect eligibility for an elective payment, tax-exempt bond financing may result in a reduction of the underlying credit amount. For example, the section 48 energy credit may need to be reduced if it’s funded by tax-exempt bonds. Organizations should carefully analyze how their projects are funded and whether the funding will reduce the credit.

How are direct payments claimed for applicable credits?

Tax-exempts have been eagerly awaiting the answer to this question for several months. While the IRS provided organizations with the steps generally required to receive an elective payment, the process will not be launched until late 2023.

Before any elective payment can be considered, organizations must determine which tax credit(s) they may be eligible for and verify any pre-application procedures have been (or will be) met. Thereafter, there are some important steps that must be taken to ultimately secure the payments.

Pre-filing registration

The IRS is creating a registration process for all entities intending to pursue elective pay. This must be completed prior to filing the tax return where a direct pay election is made (see below). The process will involve providing certain information about your organization, the credits you intend to claim, and details regarding the property giving rise to the credit.

Once the registration process is finished, a registration number will be issued that will be required when making the election on your organization’s tax return. Additionally, the IRS will issue a separate registration number for each applicable credit property where you provided sufficient and verifiable information.

A registration number is valid only for the taxable year for which it is obtained. Registration numbers must be renewed each year an elective payment will be sought.

The IRS has indicated that more information regarding pre-filing registration will be available when the process is released later in 2023.

Making the election on a tax return

The election is made on an organization’s annual tax return in the manner prescribed by the IRS, filed with any forms necessary to claim the applicable credit, a completed Form 3800, General Business Credit, and any additional information required in the instructions to the relevant forms.

For this purpose, the term “annual tax return” means the tax return an organization is required to file with the IRS. State, local, and tribal governmental entities that typically do not file tax returns will now be required to file a Form 990-T to claim elective payments for applicable credits.

An election can only be made on an original, timely filed return (including extensions). For most tax-exempt and governmental entities, this is four-and-a-half months after the end of the entity’s tax year. An election cannot be made on an amended return, and no other late election relief is available including via private letter rulings. It’s critical your organization secures the election on its originally filed tax return. Once made, the election is irrevocable except in very limited circumstances.

Credit transfer opportunities for taxpaying entities

For entities not eligible for elective pay, the IRA has created a credit transfer program allowing taxpayers to buy and sell certain credits. Companies that cannot take advantage of the credits they generate (due to tax losses for example) can now sell their credits for cash. Companies with an appetite for tax savings can purchase IRA credits, typically at a discounted price compared to the credit’s face value.

Credits eligible for transfer are the same ones available for elective pay, except the section 45W commercial clean vehicle credit, which is not eligible for transfer.

Like the elective payment process, taxpayers will need to complete pre-filing registration with the IRS if they intend to transfer some or all of an eligible credit.

Who can buy eligible credits and how are they purchased?

Only taxpayers that are unrelated to the seller may purchase an eligible credit, and they must be purchased solely for cash (i.e., U.S. dollars only, no foreign currency or cash equivalents are permitted). Once the purchase is lined up, a transfer election statement must be arranged between the buyer and seller.

What’s a transfer election statement?

While taxpayers have some flexibility in terms of the exact form of the transfer election statement, it generally must include the name, address, and taxpayer identification number for both the buyer and seller; a description of the type and amount of the eligible tax credit being transferred; the amount of cash paid for the credit; and the registration number related to the credit property.

The statement must also include an attestation that the seller is not related to the buyer and a representation acknowledging the notification of recapture requirements (see below).

Who bears the risk of credit recapture?

For eligible credits under sections 48, 48C, 48E, and 45Q, the transferee bears the financial responsibility for a recapture event. The transferor is required to notify the transferee if a recapture event occurs. For other eligible credits, recapture is not applicable.

How we can help

CLA’s energy incentives team can help your organization identify available credits under the IRA, navigate through the registration process, and claim available credits on your tax return. Additionally, our fixed assets team will work seamlessly to segregate costs for your investment credit property to determine eligible basis and your overall credit benefit.

Contact CLA to learn how your organization can take advantage of green energy credits under the IRA.