Local governments and nonprofits can get more than half of their clean energy project paid back with elective pay. In June 2023, the IRS expanded nontaxable entities’ access to Inflation Reduction Act (IRA) tax credits with the addition of elective pay (also commonly called direct pay). Elective/direct pay not only allows these entities access to these tax credits, but also multiplies the credit amount to cover a significant portion of the cost of the project. However, the application process is challenging, and payment occurs after project completion. This article will cover eligibility, how the application process works, and future changes.

Eligibility

The IRA created unprecedented funding for clean energy technologies in the form of tax credits. There is both a clean electricity production credit (Section 45Y), which includes hydrogen, carbon sequestration, and nuclear; and a renewable electricity production credit (Section 45), for wind, solar, biomass, hydropower, and geothermal.

As nontaxable entities, local governments and nonprofits were unable to receive these tax credits until the recent addition of elective pay. Until this addition, tax-exempt and government entities could not tap into the IRA funds because they did not owe any federal taxes. Elective pay allows applicable entities to receive a tax-free cash payment equal to the full value of tax credits for their qualifying clean energy project. Under these recent changes, the following entities are considered applicable entities for elective pay:

• Tax-exempt organizations under § 501(a), including §501(c) and §501(d).
• State and political subdivisions (local governments).
• Indian tribal governments.
• Agencies of state, including water districts, school districts, economic development agencies, public universities, and hospitals.
• The Tennessee Valley Authority.
• U.S. territorial governments and subdivisions.
• Rural electric cooperatives.

How It Works

Elective pay allows these entities to access 12 of the IRA tax credits. Of the 12 tax credits, the most relevant for clean energy are the production tax credit and investment tax credit. For the full list of applicable tax credits and technologies, see the IRS’s Elective Pay Eligible Tax Credits List.

The production tax credit (PTC) can be used for clean energy generation and community solar. PTCs are based on the total energy produced and sold by applicable renewable energy facilities. Currently, PTC will pay 2.75 cents per kilowatt-hour produced by a facility every year for the first 10 years of that facility’s life. ITC can be used for clean energy generation, battery storage, community solar, EV charging infrastructure, and purchasing clean vehicles for state or city vehicle fleets.

Investment tax credits (ITCs) refund a project based on a percentage of the eligible cost for the project. These tax credits use a base and a bonus credit structure. The base for ITC is 6% but gets multiplied by five (up to 30%) if following the prevailing wage and apprenticeship requirements. The requirements are extensive, but projects under 1 megawatt are automatically approved.

In addition, there are three bonus tax credits that can increase this amount further: the domestic content bonus, energy communities bonus, and low-income communities bonus. The credit amount for these can be seen in the figure below. If combined, these tax credits can refund 60%–70% of the cost of a clean energy project.

For a more detailed explanation of the bonus credits, visit the IRS’s Credits and Deductions Under the IRA page.

The timeline for this repayment program begins after the clean energy project goes into service. Before the tax return year that the project went into service, there is a prefilling requirement done through the IRS electronic portal. After the prefilling, you will receive a registration number from the IRS. File the tax return by May 15 (tax day for tax-exempt entities), and you will receive the direct payment after it is processed. The prefilling requirement is quick and cannot be amended in the tax form.

Future Changes

The domestic content bonus will become a requirement moving forward. If the requirement is not met, eligible projects starting in 2024 receive 90% of the direct payment, projects starting in 2025 will receive 85%, and projects starting in 2026 and beyond will receive no payment. There is an option of getting a waiver if the cost is too great, and we are currently waiting for guidance on this from the IRS.

Beginning in 2025, the tax credits will become tech-neutral. When the current PTC and ITC expire in 2024, they will be replaced with Clean Energy PTC and Clean Energy ITC in 2025. Currently, these tax credits only cover the technologies outlined in the IRS’s eligible tax credits document. This change means these tax credits will be tech-neutral so that they can apply to any electric generating facility with net-zero greenhouse gas emissions. This will be a huge help for new and emerging technologies, like clean hydrogen, to be included in the funding. In addition, energy storage will now be able to apply for clean energy ITC as a standalone, instead of being an add-on for another renewable generation facility.

Final Notes

The payment amount promised by elective pay is higher than any clean energy repayment program to date. In addition, these tax credits can be tied to bonds, loans, and grants, and added onto accelerated depreciation. However, with steep restrictions and delayed payment, many local governments and nonprofits are concerned about diving right in. Some developers are already leading the charge on maneuvering through the restrictions and requirements to receive the tax credit. The city of Chicago had already planned to put solar panels on some of their libraries and is now adjusting their project to receive elective pay funding. As these developers experience which applications get accepted and which get denied, the tax credits will become more accessible to everyone. ICMA offers resources and assistance with the application process through programs like SolSmart, Solar@Scale, Technical Assistance to Brownfields (TAB), and the Thriving Communities Technical Assistance Center (TCTAC).

Countries around the world are waiting to see how effective IRA and elective pay tax credits are at increasing green infrastructure in the United States while keeping capital domestic, replacing greenhouse emitting infrastructure, and assisting low-income communities. With these tax credits expected to be usable for a long time into the future, it is important to learn the ins and outs of successful applications.

BENJAMIN POWELL is an assistant project manager at ICMA (bpowell@icma.org).