ImpactAlpha, Oct. 19 – Just a year after its passage, the Inflation Reduction Act has helped kickstart new battery and EV manufacturing plants in the US. In the solar industry, the IRA’s billions of dollars in funding and accessible financing are enabling greater efficiency and scale.
A lesser known but equally powerful provision that has captured our imagination.
“Direct pay,” also referred to as “elective pay,” enables nonprofits and other tax-exempt entities, including municipalities and Tribes, to directly benefit from the federal tax credits that have long been the primary incentive for the deployment and operation of clean energy projects across the country. The provision is a gamechanger for community ownership.
In Baltimore, our company, Groundswell, is developing a “community resilience hub” at the City of Refuge that uses solar and energy storage to provide essential services to local residents if the power goes out. The energy savings will also free up money that the faith-based nonprofit can spend on community services. “Direct pay” tax credits were key to making the project work.
The tax rebates will cover one-third of the $500,000 project cost. The remainder is financed by local reimbursable grants.
Before the IRA: Economically Exclusive Solar Ownership
The primary national incentive for solar energy has long been the solar tax credit (formally known as the “Investment Tax Credit” or “ITC”). While tax credits have been an effective mechanism for developing a thriving US solar market, relying on them as a primary national incentive mechanism limited access to the benefits of solar ownership to wealthy people and companies that could use tax credits to reduce their tax liability.
That’s because tax credits, on their own, reward wealth with ownership.
In contrast, community-based nonprofits, churches, public schools, and other tax-exempt organizations had to access solar energy by purchasing it from solar projects (including solar projects on their own roofs) that were owned by private companies and tax equity investors – typically by using a power purchase agreement, or PPA. This approach generated environmental benefits and energy savings, but the benefits came at a premium price compared to direct ownership.
After the IRA: A Path to Inclusive Ownership
Nestled within the multitude of clean energy investments in the IRA is the new “direct pay” provision. For the very first time, it makes many IRA tax credits, including the solar tax credit, directly payable to nonprofits, municipalities, Tribes, and other non-taxable entities. For these institutions, the additional potential solar savings and other benefits available through ownership mean more money for the mission as well as greater local control.
In addition, for solar developers and finance providers, this groundbreaking policy presents a new opportunity to create solutions that promote inclusive clean energy access through direct investments in under-resourced communities, consistent with the Biden administration’s Justice40 policy.
This summer, the US Department of the Treasury and the Internal Revenue Service published proposed guidance on how the “direct pay” option will work. The agencies are expected to finalize guidance in the fall.
Based on the current draft, to receive the value of the solar tax credit, eligible tax-exempt organizations will be able to “pre-register” their intent to pursue the “direct pay” option to streamline the filing process. They would then be able to file to receive “direct pay” tax credits in the same tax year during which their project completes construction and is placed in service. The process is similar to filing your individual tax return and receiving your refund once your return is accepted.
The draft guidance also makes it clear that the solar tax credit and “direct pay” provision can be stacked alongside grant sources of project funding, so long as the total value doesn’t exceed the cost of the project. That means, for example, that a community-owned solar project could be partially funded by a philanthropic or government grant, with the balance of project costs covered by solar tax credits.
The draft IRS guidance also includes a “transferability” feature that enables for-profit entities without a large enough tax liability to sell their tax credits on the open market for a tax-free cash payment. This additional provision further expands access to solar ownership.
The IRA also includes incentives to encourage an inclusive clean energy economy. In August, the Treasury Department announced final guidance for the Low-Income Communities Bonus Credit Program (also known as 48e), which offers a 10% or 20% bonus to the solar tax credit for projects located in, or that serve, underinvested communities. When combined with the 30% solar tax credit, these bonus tax credits could potentially cover 40-60% of the cost of an eligible project, thereby enabling additional energy savings and expanding the benefits of community ownership.
Projects seeking bonus credits will be required to complete an application process through which the Treasury and IRS can ensure all qualifying projects are accountable to the program’s goals. The Department of Energy will begin accepting applications on behalf of the IRS for this program in early fall.
Putting Direct Pay and the Bonus Tax Credits into Action
Based on current IRS guidance, the value of the solar tax credit and any bonus credits would be paid out after a project is completed and achieves permission to operate. That means tax-exempt entities seeking to use “direct pay” will need to secure financing to cover up-front predevelopment and construction costs. The value of “direct pay” tax credits in combination with available state and local incentives, together with the resulting electricity bill savings, can be used to pay back any loans or other financing costs incurred once the solar project is operational.
Community development financial institutions, or CDFIs, and other community-based lenders will be important partners in providing the financing nonprofits may need. For example, Rochdale Capital, a community loan fund, provided a $500,000 loan to cover the upfront costs of the City of Refuge project. The project, which will begin construction this fall, will serve as a leading example for how other local nonprofits can use “direct pay” to achieve community ownership.
It’s one example of what will no doubt grow into a nationwide wave of community-owned projects that demonstrate why “direct pay” is among the most important policy tools the IRA delivers to build an equitable and economically inclusive clean energy economy.
Michelle Moore is Groundswell’s CEO. Dr. Elvis Moleka is VP of Data Science and Research at Groundswell.
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