As you consider ownership and financing options for a renewable energy project, you will need to understand the new mechanism of direct 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 Your City
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 your 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 your city:
- 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 your city from purchasing electricity from a third party
Stay Tuned for Key Details
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.
While your city should start to plan with direct pay in mind, details about how this new mechanism will operate are currently limited. It is likely that tax-exempt entities will file their taxes and receive a refund as if they overpaid on those taxes. The IRS is expected to release further guidance and specific requirements for taking advantage of direct pay in 2023.
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 your city advances renewable energy and other decarbonization-related projects. Check back here for updates as federal agencies release additional guidance.