The $268 billion package of energy tax incentives recently enacted as part of the Inflation Reduction Act (IRA) creates unprecedented new opportunities for tax-exempt entities. The bill generously enhances and extends existing incentives, while also creating several new energy credits. More importantly, new options to monetize the tax incentives were crafted specifically so tax-exempts could benefit.
The growing interest across the economy in environmental, social and governance (ESG) initiatives is even more pronounced in the not-for-profit space. Many tax-exempts have set aggressive environmental goals or are eager to show stakeholders they are committed to reducing their carbon footprint. The new energy incentives will give tax-exempts the economic tools to make their physical spaces more energy efficient, green their fleets, or even generate their own electricity.
A drawback to many tax incentives is that they provide little benefit unless the entity claiming them is paying tax. That is why many incentives fail to drive the intended activity in the tax-exempt space. Lawmakers writing the IRA recognized this barrier and created a special election under new Section 6417 that allows tax-exempt entities, state and local governments and instrumentalities, Indian tribal governments, the Tennessee Valley Authority, Alaska Native Settlement Corporations, and rural electricity cooperatives to elect to receive the new and enhanced energy credits as refundable tax payments. This will allow tax-exempts to fully benefit from the credits even if they have no unrelated business income or pay no tax. There are also new ways to monetize the enhanced deduction for energy-efficient commercial property, as discussed below.
Grant Thornton insight: Property placed in service after 2022—even for projects already under construction—can generally qualify for the refundable payment election. Fiscal year taxpayers, however, should note that the statutory language seems to limit the election to tax years beginning after Dec. 31, 2022. So, tax-exempts could lose the direct pay option for property placed in service after 2022 if their tax year began before 2023. For tax-exempt entities that do not file tax returns, guidance will be issued by Treasury on the timing and process for claiming the direct pay tax credit.
The IRA enhances and extends the two tax credits generally available for projects generating energy from renewable sources such as wind, solar or geothermal: the Section 45 Production Tax Credit (PTC) and the Section 48 Investment Tax Credit (ITC). In the past, the ITC was specifically barred for tax-exempt entities, and taxpayers could not claim it even if those entities were leased to tax-exempt entities. This forced tax-exempts and government entities, particularly colleges and universities, to enter complicated transactions in which third parties retained ownership of the property and sold the electricity back to ineligible entity. The new direct pay mechanism discussed above will allow tax-exempts to directly benefit from renewable projects, which may range from large wind or geothermal projects to a simple array of solar panels on the roof.
The ITC generally offers a one-time 30% credit based on the cost of the project when it is placed in service. The IRA also expands eligible property to include battery storage, microgrid controllers and other equipment. Alternatively, the PTC offers a per-kilowatt credit for selling the electricity for 10 years after the project is placed in service. For most property, including wind and solar, taxpayers can choose between either credit.
Grant Thornton insight: The cost of solar has come down so quickly in recent years that the PTC may be more attractive than the ITC for many projects. But the PTC requires the electricity to be sold to an unrelated party, so tax-exempt organizations doing smaller projects for their own consumption may need to consider arrangements with their utilities or other third parties to sell the electricity.
To qualify for the credits, taxpayers must generally begin construction before the end of 2024. After 2024, the credits will be replaced by new technology-neutral versions. Taxpayers also must generally meet new prevailing wage and apprenticeship requirements on their projects to qualify for the full credit rates. The wage requirements specify minimum prevailing wages be paid based on project locations. The apprenticeship requirements require a set percentage of total labor hours be performed by qualified apprentices.
Grant Thornton insight: The wage and apprenticeship requirements will only apply to projects that begin construction 60 or more days after the IRS publishes guidance on the rules. Tax-exempt entities can consider beginning construction ahead of this deadline. A safe harbor in IRS guidance generally allows taxpayers to establish that construction has begun by paying 5% of the total project costs.
Enhanced credit rates are available for projects in which the components are sourced domestically or for projects in specific geographies. Many tax-exempts may already be operating in the low-income or distressed communities that will be eligible for enhanced rates. For projects financed with tax-exempt bond financing, not all is lost. Projects qualifying for the ITC or PTC that also qualify for tax-exempt financing can be 100% financed with tax-exempt bonds, resulting in a maximum 15% reduction in the amount of the tax credit.
Grant Thornton insight: The qualifications for both the PTC and ITC are complex. Organizations will need to work closely with advisors to make sure they meet the requirements not just around energy activities, but also workforce requirements.
Qualified commercial clean vehicle credit
The use of alternative energy vehicles has become an extremely popular way for organizations to show their commitment to their environmental goals. The IRA created a new credit under Section 45W for qualified commercial clean vehicles acquired and placed in service after Dec. 31, 2022. Unlike the general consumer credit for clean vehicles under Section 30D, this credit for businesses and tax-exempts is not shackled by stringent new battery and mineral sourcing requirements.
The nominal credit rate is 15% of the cost of qualifying vehicles with a gasoline or diesel engine or 30% of the cost of other qualifying vehicles, but is limited to the incremental cost of the vehicle relative to a comparable vehicle powered solely by a gasoline or diesel engine. The credit is also capped at $7,500 for vehicles weighing less than 14,000 pounds and $40,000 for heavier vehicles. The credit is not allowed if a Section 30D general clean vehicle credit was claimed.
Like the ITC and PTC, this credit is specifically available to tax-exempts as refundable payment, but only for tax years beginning after 2022. Lawmakers also created special rules for tax-exempts allowing them to claim the credit even if the vehicle is not subject to an allowance for depreciation, which would otherwise preclude many tax-exempts from benefiting.
Grant Thornton insight: Organizations considering an investment in commercial clean vehicles can now integrate the potential return of the clean vehicle tax credit into their cost considerations. Tax professionals should reach out across their organizations to ensure there is awareness of the credit opportunity and the timing requirements.
Tax-exempt entities greening their fleet, or simply looking to encourage electric vehicle use, can also consider the tax credit under Section 30C for installing electric vehicle charging stations and other alternative fuel refueling property. The IRA replaced the credit’s $30,000 cap per “location” with a $100,000 cap per charging station. The new credit, however, will be limited to property placed in service in non-urban census tracts and census tracts eligible for the new markets tax credit.
Grant Thornton insight: It should be noted that the Section 30C credit is not directly applicable to tax-exempt entities; however, the IRA carved out a special provision. The company that sells the qualified equipment to the tax exempt may be treated as the taxpayer eligible for the 30C credit. The provision requires that the seller disclose to the tax exempt the amount of the allowable credit. As such, tax exempts should consider whether price negotiations are warranted.
Building design incentives
The new version of Section 179D will offer tax-exempts a powerful incentive to make their physical footprint more energy-efficient. Section 179D provides for an immediate deduction for energy-efficient HVAC, lighting and building envelope property such as windows and roofing. It offers as much as $5 per square foot to reward the construction of energy-efficient commercial buildings and multifamily buildings that are at least four stories. In addition to energy-efficient ground-up construction, energy-efficient retrofits of older buildings may also be eligible.
While Section 179D is not a new provision, the IRA allows the Section 179D tax deduction to be allocated to designers of commercial property owned by tax-exempt organizations, Indian Tribal governments and Alaska Native Corporations. This expansion is a notable win for organizations with substantial real estate footprints—including colleges, universities and hospitals. Moreover, the ability for tax-exempt organizations to negotiate the allocation of the deduction to the designer also could result in substantial cost-savings in the development of new projects.
Grant Thornton insight: Guidance is expected to help organizations navigate the transfer of the credit and understand how the allocation interacts with other rules for tax-exempt organizations.
Other credits eligible for direct payment
In addition to the tax credits outlined above, many tax-exempt organizations may be interested in new provisions in the IRA allowing for a direct payment election under new Section 6417 for certain specialized tax credits. These provisions present an opportunity for tax-exempt organizations to utilize and monetize credits that may have not been accessible to them in the past. Notable direct payment credits include:
- Section 45Q credit for carbon capture and sequestration
- Section 45U zero-emission nuclear power production credit (new)
- Section 45V clean hydrogen production credit (new)
- Section 45X advanced manufacturing production credit (new)
- Section 48C advanced energy project credit
These credits generally have their own timing and qualification requirements.
Grant Thornton insight: Tax and finance professionals should participate in green energy and master planning initiatives at their organization to ensure credits are being considered and maximized by the organization.
The IRA represents a unique opportunity for tax-exempt organizations to align their value for green investments with potentially refundable tax credits. Due to the complexity of the law and specific provisions for tax-exempt organizations, tax-exempt entities should look closely at these opportunities and the requirements around them.
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