As you consider ownership and financing options for a renewable energy project, you will need to understand the new mechanism of direct pay (also referred to as elective pay). This is likely to be most relevant when you assess the economics of an on-site solar project or when you need to understand the market for your off-site power purchase agreement.
Consider the Benefits Direct Pay Offers
Before the Inflation Reduction Act, local governments and other tax-exempt organizations would generally have to sign a power purchase agreement (PPA) with a tax-liable third party to receive the benefits of any tax incentives for a new project. While PPAs have helped accelerate clean energy deployment, they can be time-consuming and complex for cities just looking to purchase clean energy —and may not even be allowed in your state.
Direct pay now allows key tax credits to be claimed directly by tax-exempt organizations. This means that a city can own a project while capturing financial benefits similar to those enjoyed by private developers. Previously, only the private sector could directly benefit from the Investment Tax Credit (ITC) and the Production Tax Credit (PTC), which resulted in many third-party deals. Direct pay is most relevant if you or a tax-exempt partner:
- Wants to own a project that would not be as affordable without tax credits
- Is in a regulated electricity market or utility service area that precludes you from purchasing electricity from a third party
Direct pay has been authorized for projects developed between December 31, 2022, and January 1, 2033. It is also noncompetitive funding, meaning there is no limit to the number of projects that can leverage this mechanism.
- Direct pay is available only after the project is placed in service.
- Payments from the U.S. Treasury will be made when are processed and sent out at the time of annual tax returns.
- If helpful, according to current guidance, non-profit organizations can apply for a 6-month extension to file their tax paperwork.
- Pre-filing registration is required and can be completed for free online through the U.S. Treasury website (coming late 2023).
- After completing pre-registration eligible entities will be provided a registration number that does not confirm eligibility.
- Pre-filing application process will open in late 2023.
- More details on process and eligibility can be found here.
Understand What Qualifies for Direct Pay
Not all tax incentives are able to take advantage of direct pay. Here are some of the key tax credits that may also be relevant to your city’s decarbonization strategy:
- Renewable Electricity Production Tax Credit (PTC) (US Internal Revenue Code, Section 45)
- Energy Investment Tax Credit (ITC) (Section 48)
- Clean Energy Production Tax Credit (CEPTC) and Clean Energy Investment Tax Credit (CEITC) (Section 45Y/48E)*
- Qualified Commercial Clean Vehicle Tax Credit (Section 45W)
- Alternative Fuel Vehicle Refueling Property Credit (Section 30C)
- Carbon Oxide Sequestration Credit (Section 45Q)
- Zero-Emission Nuclear Power Production Credit (Section 45U)
- Clean Hydrogen Production Credit (Section 45V)
- Advanced Manufacturing Production Tax Credit (Section 45X)
- Clean Fuel Production Credit (Section 45Z)
- Qualifying Advanced Energy Production Credit (Section 48C)
* The CEPTC and CEITC are similarly structured to the current PTC and ITC, respectively. However, they are zero-emissions technology-neutral and will take effect in 2025.
Direct pay, in tandem with the many tax incentives discussed here, may shape how you advance renewable energy and other decarbonization-related projects.
Domestic Content Requirements for Renewable Energy Projects
- Renewable energy projects starting construction in 2024 and 1 MW or above must meet domestic content requirements OR may only receive a refund of 90% of the 30% tax credit.
- This refund lowers to 85% of the 30% ITC for projects starting construction in 2025 and drops to 0% for projects starting construction after 2025.
- Projects that are under 1 MW do not have to meet domestic content requirements and can claim direct pay for 30% ITC tax credit regardless of when placed in service.
- Projects that do meet domestic content requirements when project is placed in service claim direct pay for 40% ITC.
Note: as of October 30, 2023, this guidance on Direct Pay is still based on proposed IRS rules. While the guidance is not yet final, it is unlikely to change significantly. The information above should not be considered tax advice and will be further updated should guidance meaningfully change.