The Inflation Reduction Act (IRA) is a landmark piece of legislation with profound implications for promoting clean energy and sustainability. While tax-exempt entities — such as not-for-profits, educational institutions and government agencies — traditionally have not benefited directly from tax credits, the IRA introduces provisions that make these incentives accessible.

Let’s explore how tax-exempt entities can leverage the IRA’s clean energy credits and incentives, focusing on the innovative direct pay election mechanism.

Overview of Clean Energy Tax Credits and Incentives

The IRA offers a broad array of clean energy credits and incentives to foster the adoption of clean energy technologies.

These include:

Energy Efficient Commercial Buildings Deduction (Section 179D)

• This deduction is available for improvements in energy efficiency, such as lighting, HVAC systems and building envelopes.
• The maximum Section 179D deduction is currently $5.65 per square foot for the entire structure.
• A tax-exempt entity can allocate its Section 179D deductions to the primary designer of its energy-efficient building and can then take that anticipated allocation into account in negotiating the designer’s contract price. A “designer” is a person who creates the technical specifications for the installation of energy-efficient property and can include the structure’s architects, engineers, contractors, environmental consultants, or energy services providers. 

Energy Credit

• This credit (sometimes called the Energy Investment Credit, which is a component of the Investment Tax Credit) supports investments for business use in renewable energy systems like solar energy, solar illumination, geothermal energy, geothermal heat pump equipment, qualified fuel cell, qualified small wind energy property, qualified microturbine property and other renewable energy technologies.
• It typically provides a 30% credit on the direct costs of the installation.
• For a tax-exempt entity, credit-eligible property that is acquired using income from certain grants or forgivable loans that were obtained with the specific purpose of acquiring credit-eligible property may reduce the amount of the Energy Credit.

Renewable Electricity Production Tax Credit (PTC)

• The PTC offers credits for the sale of electricity generated from renewable sources like wind, solar, geothermal and biomass.
• Credits are awarded per kilowatt-hour of energy produced over the first 10 years of the renewable energy facility's operation.
• For a given property, a tax-exempt entity may claim the Energy Credit or the PTC but not both credits.
• For a tax-exempt entity, credit-eligible property that is acquired using income from certain grants or forgivable loans that were obtained with the specific purpose of acquiring credit-eligible property may reduce the PTC.

Commercial Clean Vehicle Credits

• These are incentives for the purchase of qualified electric vehicles (EVs).
• They allow up to $7,500 for new EVs and up to $4,000 for used EVs.
• The credits can be up to $40,000 for vehicles rated 14,000 lbs. GVWR or higher (e.g., a school bus).

The Direct Pay Election

A game-changing provision in the IRA is the elective pay (commonly known as direct pay) election. This mechanism allows tax-exempt entities to receive refundable tax credits as direct payments from the IRS, allowing entities without tax liability to benefit financially from the credits. The direct pay election is available for 12 distinct credits, including the Energy Credit and the PTC, both discussed above.

How Direct Pay Works

The direct pay election transforms tax credits into cash payments, which can be particularly valuable for tax-exempt entities that do not have a tax liability against which the credits may apply. Here's how it operates:

• Eligibility: Tax-exempt organizations, including not-for-profits, churches, educational institutions and government entities, can make the direct pay election for several different tax credits.
• Register for Direct Pay: The entity must make an election by registering with the IRS online to treat eligible tax credits as direct payments. Although registration cannot be completed earlier than the beginning of the tax year in which the tax-exempt entity will earn the credit, the IRS recommends the entity register no later than 120 days before the entity plans to file its tax return that includes the credit. 
• Tax Return Filing: The election is typically made by including the elective pay election with timely filed income tax returns. Included with the return is Form 3800 General Business Credit, which reports the credits and associates each registration number with the credit computation. Tax-exempt entities not usually required to file an annual income tax return should use Form 990-T, Exempt Organization Business Income Tax Return, to make the elective payment election.
• Payment Mechanism: Once the election is made and approved, the IRS will issue a payment to the tax-exempt entity equivalent to the tax credit amount.

Clean Energy Applications for Tax-Exempt Entities

• Renewable Energy Projects: Tax-exempt entities can now directly invest in renewable energy projects like solar or wind installations. For example, a not-for-profit entity can install solar panels on its buildings and receive a direct payment for the value of the Energy Credit, making such projects financially viable.
• Energy Efficiency Upgrades: Institutions such as schools and hospitals can significantly improve energy efficiency. By allocating Section 179D deductions to a designer and taking those anticipated allocations into account in negotiating the designer’s contract price, these entities can reduce operational costs and total upfront costs.
• Fleet Electrification: Government agencies and non-profits operating vehicle fleets can benefit from the clean vehicle credits. By switching to electric vehicles, these organizations can lower their upfront costs by offsetting the vehicle purchase price with clean vehicle credits while also reducing operational costs.

Example Scenario

Consider a not-for-profit educational institution looking to install a solar energy system costing $500,000.  Under the IRA, the institution potentially qualifies for a 30% Energy Credit, equating to $150,000. The institution receives $150,000 directly from the IRS by making the direct pay election, significantly offsetting the initial installation cost. Additionally, if the overall project includes energy-efficient upgrades, the institution might also benefit from allocating Section 179D deductions, further enhancing its project's financial feasibility.

Conclusion

The IRA marks a transformative shift in how tax-exempt entities can engage in and benefit from clean energy tax credits and deductions. By utilizing direct pay elections, these organizations can access substantial financial incentives that were previously out of reach. This supports the transition to a more sustainable energy landscape and enables tax-exempt entities to reduce operational costs and reinvest savings into their core missions.

With economic uncertainty lingering, many organizations are prioritizing sustainability and fiscal responsibility. The IRA provides tax-exempt entities with the tools to lead by example, demonstrating that environmental stewardship and economic efficiency can go hand in hand.

Connect With US

Should your not-for-profit organization require guidance in leveraging these clean energy credits, don't hesitate to connect with one of our not-for-profit tax leaders for assistance.

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