Is your municipality aware that it can obtain payments that are federal tax credits even though it is tax exempt? The federal Inflation Reduction Act (IRA) of 2022 provides broad tax incentives for certain qualifying clean energy projects. Significantly for states and local governments, the IRA created a mechanism, known as “elective pay” or “direct pay” to deliver these tax credits to otherwise tax-exempt entities, allowing “applicable entities” (defined to include states and their political subdivisions) to receive a payment equal to the full value of the credits for qualifying projects. The payment is treated as a tax overpayment and refunded to the municipality.
There are 12 different tax credit programs available to support clean energy generation, investment in clean energy projects, government purchase of qualifying electric vehicles (EV), and installation of EV infrastructure in low-income and non-urban areas. The full list of credit programs is available here: IRS Publication 5817-G. There are bonus credits available to increase the amount of certain credits, including for: projects that paying a prevailing wage or use a registered apprenticeship program; small scale solar and wind in low-income communities or as part of a qualified low-income residential building or low-income economic benefit projects; and qualified projects in “energy communities,” which broadly means certain designated brownfield sites, or communities which have had high rates of employment in, or tax revenue from coal, oil or natural gas extraction, processing or transportation or census tracts in which a coal-fired generating unit has been retired. Applicable entities may combine tax-free grants and forgivable loans with credits, provided such funds do not exceed the cost of the project.
Once a qualifying project is complete and placed into service, then the municipality must determine its tax year and complete its pre-filing registration with the IRS. To be eligible to file for a credit through elective pay for most credit programs, the applicable entity must own the qualifying project. However, the regulations also include a provision to permit an applicable entity that owns a project through a joint ownership arrangement to opt out of partnership tax treatment to make an elective payment election to receive its share of any eligible credits.
In lieu of filing a federal tax return, the municipality files a Form 990-T to claim the credit.
Municipalities operate on a fiscal year basis, a 12-month period starting July 1 and ending June 30. Many entities file taxes on a calendar year basis, a 12-month period corresponding with the annual calendar, beginning January 1 and ending December 31. Unless a municipality has an established federal tax year, it may choose whether to file its first Form 990-T (and thus adopt a taxable year) based upon a calendar or fiscal year, assuming it maintains adequate book and records, to support its chosen taxable year. Selection of the tax year will determine the filing due date.
If all requirements are met, applicable entities will then receive tax-free cash payments from the IRS for any clean energy tax credits earned.
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