Elective Payment aka “Direct Pay” for Tax-Exempt Entities: Implementing Section 6417 for Clean Energy Projects

changing Elective Payment provision of Section 6417 of the tax code - Minneapolis Solar Energy Law Firm

We’re diving into the game-changing Elective Payment provision of Section 6417 of the tax code – often called “Direct Pay.” It’s a provision that’s shaking up clean energy financing by allowing nonprofits, tribes, local governments, and other tax-exempt groups direct access to tax credits. 

In our interview with Avisen attorney Jeremy Kalin, an esteemed renewable energy lawyer, he breaks down the implications for clean energy projects. From simplifying financing to sparking innovation, Elective Payment is opening doors for a wider range of players and broader community benefits in the renewable energy industry. 

Read on as we explore the details of Section 6417, grasp its implications, and gain practical advice for leveraging its benefits.  

What is Section 6417 of the Tax Code – and what does it mean for tax credit investors? 

Jeremy Kalin: Section 6417 is the new section of the tax code that Congress included in the Inflation Reduction Act that allows nonprofits, tribes, local governments, and other tax-exempt organizations to get a direct payment of a few clean energy tax credits, including the investment tax credit.  

For the first time since a brief period after the American Reinvestment and Recovery Act back in 2009 – which had a similar program called the 1603 Grant In Lieu Of Credit – community-benefiting organizations, nonprofit organizations, and publicly-owned clean energy project owners don’t need to find tax credit investors in the private market and instead, they can much more efficiently monetize tax credits like the solar investment tax credit, electric vehicle charging credits and more.  

As I’ve written before, prior to the Inflation Reduction Act, turning the investment tax credit potential value into real money required attracting one of a small group of wealthy investors. The Section 6417 Elective Payment – often called “Direct Pay” – sidesteps that need and creates a much more efficient pathway to turn that potential tax credit value into real value. 

I often like to use an example of a 300-kilowatt rooftop solar project that costs $1,000,000. That project would be eligible for a minimum 30% investment tax credit under section 48 of the tax code, which comes out to a $300,000 credit. Historically, project owners had to go and claw their way to find someone with the right kind of tax liability and let them get a significant return in exchange for investing in the project. Now, they don’t have to go through all those hoops and can just directly claim the credit themselves.  

Can you provide an overview of the final rules recently issued by the IRS concerning the direct payment option for clean energy credits? 

Kalin: The clean energy industry and marketplace have been eagerly awaiting these final rules because projects that were placed in service and completed in 2023 (and after) are eligible for direct payment for this elective payment credit.  

While the IRS released the proposed rules for Elective Payment late last year, and we could rely on those for projects to date, we did anticipate getting these final rules at some point early this year. 

Largely, the final rules stayed consistent to the proposed rules released in 2023, though the IRS received a lot of feedback in some areas left a bit more gray. And while there are still a few discrete topics on which the IRS wants to continue collecting comments on, the process and final rules are efficient. Kudos to the IRS team that put in a lot of work making 6417 practical in most intended cases. The final rules are clear enough, at least for those of us who live in the tax world, to be able to provide guidance to nonprofits and other tax-exempt organizations. While it’s probably not as simple as just proceeding on your own, if you’re a municipality or a tax exempt 501(c)3 nonprofit, you probably do need to check with a lawyer or a tax accountant to make sure that you’re complying. But the only disappointment in the final rules was the IRS feeling bound by statutory language passed by Congress; they were unable to change the timeline for getting the payments out to eligible organizations. 

I mentioned that 2023 projects are eligible for the credit, and it’s important to know that projects become credit-worthy for the year they’re placed in service. So, a project placed in service in 2023 that is owned by a tax-exempt organization, like a 501(c)3 tax-exempt nonprofit corporation, that charity will not be able to file for the credit until November 15th of 2024. 

I’m reminding my clients that we don’t know how fast the IRS will turn around processing those payments. So, if you have a project you had to pay for in 2023, you may not see those proceeds until the end of 2024, even early 2025. You should include in your budgetary assumptions that it could take 12 to 24 months to see the actual revenue from the credit. 

But the good news is you should get 100% of the credit claim that you make, if you submit it properly. The form filing and the pre-registration process are all essentially as we expected them to be.  

How does the Section 6417 Elective Payment / “direct pay” and these final rules specifically impact clean energy developers, investors, and projects in general? 

Kalin: Before the Inflation Reduction Act, the effect of the clean energy tax credit, specifically the Investment Tax Credit (ITC), really was that we were making wealthy people wealthier. In the world of community-owned clean energy projects, you had to make sure that you were navigating the narrow parameters of the tax code with your overall goals of ensuring community benefit. 

Now, those missions can be much better aligned. I think that we’re seeing lenders recognize this need for swing loans for the 24 months of the ITC for direct pay. We’re also seeing financial products and loans match up easily to make financing these projects bearable for developers, system owners, and beneficiaries.  

My experience used to be that people would ask me how can I find those tax credit investors? “I’ve got the project all lined up, I’ve sold it, I’ve got the power purchase agreement, project’s ready to go, I’m just waiting for money.” And I said, “You and everyone else…” 

Now, the other real innovation is, rather than having to set up a for-profit tax equity partnership as a special purpose LLC, we can partner with tax-exempt organizations that own and operate the systems for at least five years, but who can do so and get the direct payment of the credit. I caution folks, however, that you can’t just assign the credit to a nonprofit, you can’t just sell the credit to a nonprofit; the nonprofit must be the full owner responsible for all the solar ownership and the risk and loss. 

Because of that, it’s not for everybody. But it does allow sidestepping the frustrating challenge of trying to get investors who are typically instead looking for large investment-rated credit deals in the tens of millions of dollars are more. 

It’s also critical to consider the limited ability to monetize any depreciation deduction benefits. Because the depreciation expense deduction is exactly that, a deduction from the total amount of taxable income, for a tax-exempt organization, they typically don’t have any taxable income. 

For a for-profit developer, the depreciation deduction can be as valuable or more valuable than the credit. But for a tax-exempt organization, that depreciation deduction doesn’t get monetized. There may be an opportunity for organizations that sell their project after the recapture period to a for-profit entity to explore whether that depreciation deduction has value. 

But at the least, it won’t get recognized for seven years or longer. This is sometimes called “stranded depreciation.” 

What clean energy projects are eligible for Elective Payment? 

Kalin: A dozen credits are eligible for direct pay. The investment tax credit, under section 48, covers everything from ground source heat, solar, wind, biomass and biogas projects, methane capture, alternative fuel vehicle refueling property credit, also known as the EV charging infrastructure tax credit, etc. That’s probably where most of my work happens. The clean hydrogen credit and the carbon sequestration credit are eligible under 45Q. 

While there’s slightly different rules, because more than just nonprofits can take advantage of them, the 45X advanced manufacturing production credit is also eligible for direct payment. It will be interesting to see how innovation develops in those other credits, but certainly for section 48, securing the Elective Payment option under 6417 is pretty straightforward – at least compared to other sections of the tax code! 

What are the opportunities for expanding access to solar and innovation in the clean energy sector overall? 

Kalin: Local governments have a huge opportunity to capture the methane from their wastewater treatment plants and turn it into a productive use or into pipeline quality renewable natural gas. Methane is such a potent greenhouse gas – 10 times more potent than carbon – that the science and engineering of methane digestion at wastewater plants has been compelling, but thanks to Section 6417, the economics have really improved.  

As we’ve advised many municipal clients already, how often do you get to go to your engineers or go to your budget office and say, our project cost has dropped by 30 percent? And that’s the reality.  

We’re already seeing a lot more of those projects that make a lot of sense from a simple payback and carbon and greenhouse gas perspective become financeable. I think also the access to the credit to reduce the overall cost by 30 percent or more for affordable housing projects, for nonprofits like synagogues, mosques, churches, communities of faith, means we’ll see an increase in these projects overall. 

I think any number of situations are going to be able to more easily rely on the ITC as real money in project budgeting. 

Can you explain the significance of the no-excess-benefit rule clarified in the final regulations, and how it applies to clean energy organizations? 

Kalin: It’s vital for funders, as well as investors, lenders and developers to understand the thinking behind this “no-excess-benefit” rule, the application, and some new opportunities to comply with the rule to maximize direct pay’s economic benefit.  

The essential idea is that if you take all your tax-exempt income, forgivable loans, and grants, and add that to the credit value, the total cannot exceed the cost of the project. 

So, let’s talk about that million-dollar project… and let’s assume you received $750,000 in grants from federal or state funds or from a foundation, for the purpose of acquiring that project, buying the equipment, or paying for the construction of that project. If your credit value was $300,000, that plus the $750,000 exceeds the $1,000,000 in total project cost. So, the answer under the “no-excess-benefit rule” is to just reduce the credit. In this example, the $300,000 credit would be reduced to $250,000.  

I was pleased to see that the final rule maintained the proposed rule parameters of defining that tax-exempt income as for the purpose of constructing, acquiring, developing that project. Because there are some workarounds that comply with the rule but allow for some of those grant proceeds to be perhaps placed in an escrow account to be used to pay for operation and maintenance of a system. 

For instance, a nonprofit client is installing solar on the roofs of low-income owner-occupied housing, paying for the solar, and operating it for 20 years. They were able to convince their funder to deploy funds for the operation and maintenance in a way that allowed them to retain the full amount of the credit.  

I think this is an area where folks could get too cute by half, and I want to caution against making assumptions that there are easy workarounds, because you do have to comply with the rule. Otherwise, you will get hit by the IRS with a recapture of the tax credit and penalties. 

What risks are there for those claiming these credits? 

Kalin: The Inflation Reduction Act additions to the tax code are very clear that a taxpayer claiming Section 6417 direct pay of these credits is treated in the same manner as a standard for-profit tax credit claimant. 

In that, that nonprofit or municipality or tribe must own the system, have title to the system, have control of the system, have responsibility for the operation and maintenance and insurance of the system, and bear the risk of loss for that system for at least five years, which is the recapture period. That recapture exposure is 100% of the credit value in the first year, 80% in the second year, and continues stepping down by 20% each year. Those without an eligible claim may also be exposed to a potential penalty equal to 20% of that credit value on top of the recapture of the credit itself. 

I’m always advising clients that it’s better to take a few more hours to get it right up front than it is to have to pay for a lengthy audit defense. 

The regulations reject calls for allowing the chaining of credits. Can you elaborate on the reasoning behind this decision and its implications for clean energy projects? 

Kalin: The sister provision to 6417 is Section 6418, which allows for the first time that a tax credit can be transferred and sold in a raw form rather than through a partnership investment or other vehicle. 

Section 6418 allows a for-profit entity – any entity that’s not eligible for elective payment – to sell the credit to somebody who’s not involved in the ownership entity, typically a partnership, for that energy project. Chaining is the term that the IRS is using to describe a potential event where a nonprofit or other tax-exempt organization were to buy the credit from that for-profit entity. And the IRS says you can only do so if the credit buyer has Unrelated Business Income Tax (UBIT). 

For instance, I have a client that has some UBIT, and we are evaluating whether they have enough UBIT to offset the credit so they could just buy the credit through a 6418 transfer. If the answer is no, they don’t have that ability, then they will need to pursue direct ownership of the energy property and submit their credit claim via Section 6417 instead.  

However, the final 6417 rules made clear you can’t sell the credit to a nonprofit who’s going to then make the 6417 election. This rule makes a lot sense – otherwise, imagine that every single project in the country sold their tax credit, and then a nonprofit tax-exempt org claimed it as a direct payment. The statute is very clear that Congress did not intend this, and the IRS essentially said, it’s not possible. You can’t turn this into a blank check that’s going to bankrupt the federal budget. 

Can you see evidence of commenters or industry feedback impacting the final rules? 

Kalin: I see the IRS was thoughtful in taking in the questions and comments from some of my clients and many others. For instance, I know that some for-profit cooperatives who are developing solar projects sought to understand whether they met the definition of an applicable entity that was eligible for 6417 treatment. Interestingly, the IRS response in the final rule took five pages to explain the fundamental law in other parts of the tax code to finally get to the answer that, unfortunately, if you’re a cooperative association subject to subchapter T of the tax code, you’re not exempt from subchapter T. And therefore, you’re not a tax-exempt entity. 

It’s a sound argument, and they didn’t dismiss the requests out of hand. I appreciated that very much – and I think my client did, too.  

The same can be said about concerns related to timing of filing and payment of the credit for 6417 claimants. The IRS final rules and explanation laid out reasonably why they felt like the Inflation Reduction Act legislative language required that they wait until the end of the extension period for tax returns for tax-exempt organizations, which is in November, to be able to start processing payments.  

They don’t always get it right. There are other rules related to the IRA energy credits where I think they’re not getting it as clear. But in general, they’ve been thoughtful and thorough. 

How do these regulations impact the overall landscape of clean energy financing and investment, and what strategies should clean energy businesses consider in response? 

Kalin: The pathway to monetizing the clean energy credits is much more straightforward for tax-exempt organizations. I think those working in this space that have a public mission beyond just climate action and low carbon power generation should really think about partnering with other community organizations that may be eligible for direct payment. It’s so much more cost-effective now to use Section 6417 Elective Payment. 

And there are innovations happening weekly that I’m hearing about through trade organizations and working groups. I think we’re going to see a lot of creative and worthwhile ideas about structuring projects to maximize the benefit to those community organizations, low- and moderate-income Americans, public budgets, and other stakeholders. 

When do these rules come into effect, and what steps should clean energy companies take to ensure compliance with the rules and maximize the benefits available from the Section 6417 Elective Payment option? 

Kalin: The rules take effect May 10th. So, projects that are placed in service from that date onward have to comply with the final rules. But like I said, they’re so similar to the proposed rules, with very few changes. 

Most importantly, I think clean energy developers, owners, investors, and others in this space could either choose to cure their insomnia by reading the 180+ pages of the final rule, or they could contact me or another clean energy tax lawyer to walk through their ideas and to ensure that they’re in compliance with the rules. We can help them maximize the value to their projects’ beneficiaries and confirm their compliance.  

If you’re interested in learning more about tax credits available to your renewable energy project, please contact Jeremy Kalin and he or another member of the Avisen Legal team will be in touch with more information. For additional information on solar options for small business owners and non-profits, make sure you read Jeremy’s article series, “How to Better Understand and Benefit from Solar Tax Incentives.”  

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Jeremy Kalin

Jeremy Kalin

As the son and grandson of small business owners and as a “recovering” former politician, I believe that private enterprise can help solve some of the big challenges we face in our world. That we are all better served when for-profit, nonprofit and public institutions all pull on the rope together. Read Jeremy's Bio.

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