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February 22, 2023

Inflation Reduction Act Opportunities for Tax-Exempt Entities

Advisory

Background

The Inflation Reduction Act (IRA) of 2022 provides significant incentives for taxpayers and tax-exempt entities to invest in clean energy projects. In addition to expanding the types of projects eligible for the existing Production Tax Credit and the Investment Tax Credit and introducing a slate of new tax credits, the IRA allows tax-exempt organizations, states, and municipalities to receive many clean energy tax credits in the form of direct cash payments for the first time.

The Production Tax Credit

The Production Tax Credit, found in Section 45 of the US Internal Revenue Code of 1986, as amended (the Code), provides a tax credit for the production of electricity from renewable sources.

Eligibility: Facilities generating electricity from wind, biomass, geothermal, solar, small irrigation, landfill and trash, hydropower, and marine and hydrokinetic renewable energy may claim the credit for wind, geothermal, and solar (and other specified technologies) projects placed into service after 2021 and beginning construction before 2025.

Credit amount: The base credit is $0.03 per kilowatt hour, adjusted for inflation, with a credit of 1.5 cents per kilowatt hour available for projects that meet prevailing wage and registered apprenticeship requirements. The credit is increased by 10 percent if the project meets certain domestic content requirements for steel, iron, and manufactured products. The credit also is increased by 10 percent if the project is located in an “energy community,” defined as an area that has a recent history of extracting, processing, transporting, or storing fossil fuels.

The Investment Tax Credit

The Investment Tax Credit, found in Section 48 of the Code, provides a tax credit for investment in renewable energy projects.

Eligibility: Fuel cell, solar, geothermal, small wind, energy storage, biogas, microgrid controllers, and combined heat and power properties may claim this extended credit for wind, geothermal, solar, and energy storage technologies projects placed in service after 2021 and beginning construction before 2025.

Credit amount: The base credit is 6 percent of the qualified investment and is increased to 30 percent for projects that meet certain prevailing wage and apprenticeship requirements. As with the Production Tax Credit, there is a 10 percent bonus credit for a project meeting certain domestic content requirements and/or located in an energy community. Further, projects located in certain underserved communities are eligible for an additional 10 or 20 percent bonus tax credit.

Production and Investment Tax Credit Phase Outs

Both credits phase out over four years beginning when the annual greenhouse gas emissions from the production of electricity in the United States have fallen 75 percent from 2022 levels, or 2032, whichever is later.

Direct Pay Elections for Tax-Exempt Entities

Prior to the IRA, many tax-exempt entities, which often owe little or no federal tax payments, could not benefit from available clean energy credits, such as the Investment Tax Credit and the Production Tax Credit. In order to promote broad-based investment in clean energy, the IRA allows certain tax-exempt entities to elect under newly enacted Section 6417 of the Code to receive many clean energy credits as a direct cash payment from the Treasury Department. This new incentive will attract tax-exempt entities into the market for clean and renewable energy projects.

Eligibility: Tax-exempt organizations, states, political subdivisions, Indian Tribal governments, Alaska Native Corporations, rural electricity cooperatives, and the Tennessee Valley Authority are eligible to elect to receive certain clean energy tax credits in the form of direct cash payments for taxable years beginning after December 31, 2022. Entities making this election are treated as making a federal tax payment equal to the amount of the credit, resulting in a refundable overpayment of tax.

Eligible tax-exempt entities may elect to receive direct payment for the following credits:

  • Alternative fuel vehicle refueling property (Section 30C);
  • Renewable electricity production for qualified facilities that are placed in service after December 31, 2022 (the Production Tax Credit under Section 45);
  • Carbon oxide sequestration for qualified facilities that are placed in service after December 31, 2022 (Section 45Q);
  • Zero-emission nuclear power production (Section 45U);
  • Clean hydrogen production for qualified facilities that are placed in service after December 31, 2012 (Section 45V);
  • Qualified commercial vehicles (Section 45W);
  • Advanced manufacturing production (Section 45X);
  • Clean electricity production (Section 45Y);
  • Clean fuel production (Section 45Z);
  • Energy investment (the Investment Tax Credit under Section 48);
  • Qualifying advanced energy projects (Section 48C); and
  • Clean electricity investment (Section 48E).

Logistics: Generally, direct pay elections must be made by the tax return due date of the taxable year for which the election is made. For governments or political subdivisions that are not obligated to file tax returns, the deadline for making the election will be determined by the Treasury Department in future regulations. Once made, direct pay elections are irrevocable.

The Treasury Department and the Internal Revenue Service have indicated that guidance implementing the direct pay election is forthcoming, including with respect to the time and manner for making an election and overlap with non-tax legal requirements that may affect a tax-exempt entity’s ability to make such an election.

© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.