Inflation Reduction Act – Elective Pay

Last month, GFOA reported the Internal Revenue Service’s (IRS) release of the proposed rules for clean energy tax credits under the Inflation Reduction Act (IRA). Since then, the IRS has had a few informational webinars on the elective pay (a.k.a. direct pay) aspect of the credits. The comment period is currently open, and feedback can be submitted until August 14, 2023. The final rule is expected to be released later in 2023. Here’s what GFOA has gleaned so far based on the proposed guidance:

The credits and elective pay option are unique in that tax-exempt and governmental entities that do not owe Federal income taxes will, for the first time, be able to receive a payment equal to the full value of tax credits for building qualifying clean energy projects or making qualifying investments. Elective pay allows entities to get their payment if they meet the requirements for both elective pay and the underlying tax credit.

In general, entities interested in pursuing the credits should keep the following points in mind:

• Identify and pursue the qualifying project or activity. You would need to identify what applicable credit you intend to earn, which in turn leads to pursuing the qualifying project or activity. Applicable entities can use elective pay for 12 of the Inflation Reduction Act’s tax credits as described in Q13 of the FAQs. The IRS has released a helpful table with all applicable tax credits for elective pay with more detailed descriptions. The applicable tax credits for elective pay are split into four categories, as listed below with the related credits:

• Determine your tax year. Entities would also need to determine, if not already known, your tax year since that will determine the due date for your tax return. The entities eligible for elective pay (applicable entities) would not normally owe federal income tax. However, by filing a return and using elective pay, these entities can receive tax-free cash payments from the IRS for clean energy tax credits earned, so long as all requirements are met, including pre-filing registration requirements.
• Complete pre-filing registration with the IRS. More information about pre-filing registration is found in Q31 through Q39 in the FAQs. We are still waiting for more information on pre-filing requirements and will continue to provide updates as more guidance becomes available. IRS anticipates providing more information on the process by late 2023.
• Satisfy all eligibility requirements for the tax credit and any applicable bonus credits (if applicable) for a given tax year. Essentially, you would need to place a project in service before making an elective payment election, and you would need the documentation necessary to properly substantiate any underlying tax credit, including if bonus amounts increased the credit.
• Some of the applicable credits are increased if a project pays prevailing wages and uses registered apprentices, if the project meets certain domestic content requirements for steel or iron, and manufactured products, or if a project is in an energy community.

Applicable entities under the proposed rules include, but are not limited to, States and political subdivisions such as local governments, as well as agencies and instrumentalities of state, local, tribal, and territorial governments (e.g., water districts, school districts, economic development agencies).

In general, only ‘applicable entities’ are eligible for Elective Pay. However, other taxpayers that are not ‘applicable entities’ may elect to be treated as an applicable entity with respect to three tax credits (for carbon oxide sequestration, production of clean hydrogen, or advanced manufacturing).

GFOA will be submitting additional public comment with our partners at the National League of Cities (NLC) and the National Association of Counties (NACo).