Understanding elective pay for energy tax credits

ARTICLE | September 14, 2023

Under the Inflation Reduction Act (IRA), the IRS has proposed rules for an “elective pay” provision that enables entities that wouldn’t traditionally qualify for specific energy tax credits to claim these benefits. 

Understanding elective pay

The proposed rules will benefit applicable entities, such as tax-exempt and governmental bodies, that would otherwise miss out on certain credits as they do not owe federal income tax. When these entities opt for this election, the amount of the credit is treated as a payment of tax. If there is an overpayment, it results in a refund. 

Consider a scenario where a local government undertakes a clean energy initiative that qualifies for the investment tax credit. Under the IRA, this local government can now file an annual tax return with the IRS, claiming elective pay that equals the full value of this investment tax credit. Of course, this is contingent on the local government fulfilling all the prerequisites. Given that this local government would not have any other federal income tax obligations, the IRS would then issue a refund payment equivalent to the value of the credit. 

Who is eligible? 

Applicable entities that qualify for elective pay include a broad spectrum of organizations. Tax-exempt organizations, such as public charities, private foundations, social welfare organizations, labor organizations, and business leagues, are covered. Additionally, states, local governments, Indian tribal governments, U.S. territories, and their political subdivisions can benefit from elective pay. Agencies of state, local, tribal, and U.S. territorial governments, along with Alaska Native corporations, the Tennessee Valley Authority, and rural electric cooperatives, also fall under the umbrella of applicable entities. 

Special rules extending eligibility

While elective pay typically applies only to “applicable entities,” the IRS has established special rules for three specific clean energy tax credits. These exceptions allow other taxpayers who do not fall under the “applicable entities” category to make an election, enabling them to be treated as an applicable entity for elective pay purposes. 

This election applies to: 

• The Carbon Oxide Sequestration: an initiative that aims to store carbon dioxide or other forms of carbon to prevent their release into the atmosphere. 

• The Credit for Production of Clean Hydrogen: which encourages the generation of hydrogen through environmentally friendly methods. 

• The Advanced Manufacturing Production Credit: which incentivizes manufacturing processes that employ advanced technologies for energy conservation or environmental benefits. 

It’s worth noting that additional provisions exist for taxpayers that are classified as a partnership or an S Corporation. Moreover, electing taxpayers can only elect direct pay for the tax year the project is placed in service and the four following tax years that end before 2033 (this is a shorter tax credit period than that available to applicable entities). The nuances of these special rules emphasize the importance of consulting with a tax professional to ensure accurate interpretation and application. 

How to receive the elective payment? 

Receiving the elective payment involves multiple steps: 

1. Identify the project and meet requirements: the applicable entity must identify the project or activity they are pursuing and satisfy all requirements for the applicable credit. This includes the completion of any necessary forms required to claim the corresponding tax credit. 

2. Pre-filing registration with the IRS: this will include providing information about yourself, which applicable credits you intend to earn, and each eligible project/property that will contribute to the applicable credit and other information required. After completing the pre-filing registration process, the IRS will issue a unique registration number for each applicable credit property. You will need to provide that registration number on your tax return as part of making the elective pay election.

3. Claiming the elective payment: once the pre-filing registration process is complete and the requirements for the applicable credit are met, the eligible entity can claim and receive an elective payment by choosing the election on their annual tax return. The required forms to claim the relevant tax credit must be completed and filed. Appropriate documentation is necessary to support any underlying tax credits.

It is essential to note that each applicable entity must have its own Employee Identification Number (EIN) or Tax Identification Number (TIN) to complete the pre-filing registration process. Entities that don’t have a filing requirement cannot use or borrow the EIN of a related entity. 

Eligible energy credits

Several energy credits are eligible under the elective pay provision, including: 

• Production Tax Credit for Electricity from Renewables, 

• Clean Electricity Production Tax Credit,

• Investment Tax Credit for Energy Property, 

• Clean Electricity Investment Tax Credit,

• Low-Income Communities Bonus Credit,

• Credit for Carbon Oxide Sequestration,

• Zero-Emission Nuclear Power Production Credit,

• Advanced Energy Project Credit,

• Advanced Manufacturing Production Credit,

• Credit for Qualified Commercial Clean Vehicles,

• Alternative Fuel Vehicle Refueling Property Credit,

• Clean Hydrogen Production Tax Credit, and

• Clean Fuel Production Credit. 

With these proposed rules, it is easier for applicable entities to navigate the process and take full advantage of these energy credits. Organizations should be proactive in keeping themselves updated about the upcoming additional information from the IRS regarding the pre-filing registration process. The IRS is expected to issue more guidance in late 2023. 

Remember, consulting with a tax professional can be beneficial to understand the rules and ensure that all procedures are accurately followed. 

Transferring credits

Some taxpayers may be able to convey certain energy tax credits to parties with no prior association in exchange for cash. The credits eligible for transfer are Section 30C, Section 45, Section 45Q, Section 45U, Section 45, Section 45X, Section 45Y, Section 45Z, Section 48, Section 48C, and Section 48E. 

The criteria are relatively straightforward: taxpayers must not fall under the category of “applicable entities.” Essentially, any taxpayer that doesn’t fit the description for “applicable entities” can offload all or part of the credits they are eligible for. Taxpayers may also sell credits originating from one eligible credit property to several distinct parties within a single fiscal year. 

To do so, taxpayers must undertake a project that is eligible for one of the aforementioned credits. They must also file a pre-filing registration with the IRS. They can then broker a deal with an unrelated entity, exchanging the tax credit for cash. The taxpayer’s tax return must reflect this credit transfer and include the accompanying transfer election documentation, including the registration number linked with the appropriate credit property. 

This is intended to provide a brief overview of elective pay for energy credits. It is not a substitute for speaking with one of our expert advisors. For more information, please contact our office.