Tax-Exempt Entities: New Source of Funding Available for Clean Energy Projects

Tax-exempt entities (including state and local governments) undertaking clean energy projects have historically been unable to benefit from clean energy tax credits available to private entities subject to federal income tax. However, thanks to the Inflation Reduction Act of 2022 (IRA), a local government that has made a clean energy investment is now eligible to receive a number of clean energy federal tax credits as direct, elective payments.

This blog will look at project eligibility, how elective payments work, and what a tax-exempt entity must do to claim these benefits.

Background

A key provision in the IRA made state, local governments, 501(c)(3) nonprofit organizations, tribal governments and other tax-exempt entities (“tax-exempt entities”) eligible to receive a number of clean energy federal tax credits as direct, elective payments. Tax-exempt entities can combine direct payments with tax-exempt bonds to fund clean energy infrastructure projects, with a relatively minor (15%) reduction in the direct payment.

Tax-exempt entities may elect to receive “applicable credits” as defined in 26 U.S.C. § 6417, which was added to the Internal Revenue Code as part of the IRA. These credits are then disbursed as as direct, elective payments.

The process looks like this: A local government undertakes a clean energy project which qualifies for the investment tax credit. The local government then preregisters and files an annual tax return with the IRS to claim elective pay for the investment tax credit. The local government would not owe other federal income tax, but the elective pay provisions essentially allow the local government to claim a refund for taxes it is deemed to have paid.

Eligible Projects

Cities, school districts, ports, transit agencies, and other tax-exempt entities have already claimed the elective payments for a range of qualifying projects, including solar installations, waste energy recovery, energy storage, and bus and other fleet electrification.

A list of qualifying projects and a summary of the available credits are set forth in the Clean Energy Tax Incentives: Elective Pay Eligible Tax Credits chart provided by the Internal Revenue Service (IRS). The White House also released the Inflation Reduction Act Guidebook, which covers the clean energy tax incentives in the IRA as well as the IRA’s grant and loan programs.

In many instances, the amount of the elective payment can be multiplied five times (from 6%­­­­­­­­ – 30% of eligible project costs in the case of certain investment tax credits) by meeting prevailing wage and qualified apprentice standards. Other bonuses are available, depending on the credit, for projects that meet domestic content requirements (for steel, iron, or manufactured components of the facility), projects in low-income communities, projects that are part of a qualified low-income residential building project or a qualified low-income economic benefit project, and projects in “energy communities,” which include brownfield sites and areas dependent on coal, oil, or natural gas.

Project Preregistration Required

To claim the elective payment for a qualifying project, cities, school districts, ports, transit agencies, and other tax-exempt entities must preregister each project with the IRS. Tax-exempt entities are currently preregistering projects placed in service in the 2023 tax year.

Following preregistration, the IRS will provide registration numbers for each project, which will allow a tax-exempt entity to file a tax return to claim the elective payment. For tax years ending December 31, 2023, the tax return claiming the elective payment is due by November 15, 2024 (six months after the standard calendar year due date of May 15 and taking into account an automatic paperless extension that the IRS has provided this year).

Some tax-exempt entities are electing to use the end of their fiscal year as the end of the tax year, which provides additional time to make the filing. As noted above, the IRS is providing an automatic six-month extension this year, but in future years, tax-exempt entities may need to file for an extension.

The IRS recommends that entities preregister at least 120 days before the tax return due date, so local governments should preregister any eligible 2023 projects with the IRS right now. Preregistration has also just opened for projects placed in service in tax years that begin in 2024 or later.

Tips and IRS Support

The preregistration process is new, and, in our experience, requires some troubleshooting for each entity and project. Before beginning the process, a local government should review the IRS guide to preregistration and the FAQ on elective pay and transferability.

The IRS is also holding special sessions to answer questions about this new filing system. Listening to the questions asked by other municipalities who are using the preregistration tool is helpful, and the sessions also provide a forum to ask your specific questions of IRS staff. The next special session is scheduled for 1 – 2:30 Eastern Standard Time on Wednesday, October 2, and interested parties must preregister to attend. Local governments may also use irs.elective.payment.or.transfer.of.credit@irs.gov to ask questions about the process.

Local governments should gather all the required materials before preregistering for elective payments, including entity information (including EIN), project information, and credit-specific supporting documentation. As part of the preregistration process, you can opt in to email notifications of activity with respect to your preregistration, to save you from having to log in to check status.

Once you have pre-registered, the IRS will provide you with a registration number for each applicable credit property to include on your tax return as part of making the elective pay election. The IRS may reach out with questions as part of this review.

Conclusion

Local governments should review their 2023 clean energy projects and activities to see if any qualify for elective payments and if so, begin the preregistration process for eligible projects as soon as possible. It is also not too early to be thinking about and gathering data on eligible 2024 projects.

State and municipalities don’t typically file returns, so the tax return process is new and requires troubleshooting. Some of these forms are under development. Please let us know if you have any questions.