For the first time, with the enactment of the Inflation Reduction Act of 2022 (the “Act”),^[1] federal tax law has made energy tax credits available to State and local governments, and to 501(c)(3) organizations, as cash payments. This article will provide a general overview of the Act’s provision of such payable tax credits for clean energy investments (refundable investment tax credits, or “refundable ITCs”).

Prior to the Act, the federal government offered tax credits to taxpayers making investments in clean energy, allowing taxpayers to offset those credits against their federal tax liabilities. However, these credits were nonrefundable, meaning that any excess credits beyond a taxpayer’s federal tax liability simply disappeared. Most tax-exempt entities, being exempt from federal taxes, had no liabilities to be offset and could not make use of the offered tax credits. State and local governments and other tax-exempt entities instead would sometimes enter into joint ventures with for-profit entities for any such clean energy investments so that the for-profit entity could reap the benefits of the tax credits.

The Act, however, provides that, by election, certain energy tax credits can be directly refunded as a one-time cash payment to eligible State and local governments and 501(c)(3) organizations.^[2] For State and local governments and other organizations which have no federal income tax liability, the full amount of the credit will be paid to the taxpayer by the IRS.  For 501(c)(3) organizations which do have a federal income tax liability for that year, the election can be made on the tax return (i.e., Form 990-T) for the tax year in which the credit is claimed.^[3]

Unfortunately the IRS has not yet released regulations providing the full details of how these refundable energy tax credits will be administered, but the Act itself provides a high-level overview of how the credits will work. Please note that the below discussion is meant to provide a general overview rather than to explore all of the detailed qualifications and exceptions provided in the Act.

The new program includes refundable ITCs for smaller- and larger-scale new solar, gasification, advanced energy, and clean electricity generation projects.^[4] The refundable ITCs are available to projects whose construction begins before January 1, 2025, although a different but similar regime will take effect on that date for investments in projects for which the greenhouse gas emissions rate is not greater than zero and will continue possibly as long as December 31, 2035.

The broadest refundable ITC^[5] starts at a base rate of either 6% of the cost of investments in certain (i) fuel cell property, (ii) solar energy equipment, (iii) geothermal energy equipment, (iv) small wind energy property, (v) waste energy recovery property, (vi) energy storage technology, (vii) biogas property, (viii) microgrid controllers, (ix) combined heat and power system property, and (x) small energy wind property, or 2% of the cost of investments in other energy property. The base rates are multiplied by five to effective rates of 30% and 10%, respectively, if either (i) the project has a maximum net output of less than 1 megawatt of electrical (alternating current) or thermal energy or (ii) both (a) all laborers, mechanics and workers are paid the prevailing wage for the locality during construction and (b) qualified apprentices perform 15% (or 12.5% for projects beginning construction before January 1, 2024) of total labor hours for project construction.

The Act provides a domestic content bonus credit of up to an additional 9% of the effective rate (10% for projects beginning construction before January 1, 2024) for projects in which 40% (or 20% for offshore wind facilities) of the total cost of components are mined, produced or manufactured in the United States.

The Act also provides an additional bonus of up to 20% of the base rate for certain solar and wind investments that are located in low-income communities or low-income residential building projects.

All of the escalated credit amounts beyond the base rates are subject to recapture in subsequent years if the project or property fails to remain eligible for the multiple/bonuses.

Although forthcoming regulations and additional guidance will be critical, it is clear that these refundable ITCs present a real opportunity for State and local governments and 501(c)(3) organizations to capture significant economic value in connection with the development of new clean energy projects. In particular, eligible issuers and borrowers of tax-exempt bonds for their clean energy projects may wish to develop integrated financial planning strategies that leverage the benefits of tax-exempt financing together with the anticipated value of the refundable ITCs that can be claimed as a result of these capital investments.

We note in this regard that the Act generally applies a 15% “haircut” to the amount of the refundable ITC that would otherwise be available to an eligible State or local government or 501(c)(3) organization, based on the allocation of the proceeds of tax-exempt bonds to finance all or a portion of the capital costs of a clean energy project. The amount of the “haircut” will therefore need to be assessed as part of the financial planning process for such projects. At a minimum, any party intending to claim these refundable ITCs will need to make decisions about the use of tax-exempt bonds to finance the capital costs of their clean energy projects at the time the refundable ITC is claimed. Hinckley Allen’s Tax and Public Finance Groups stand ready to assist with the development of strategies to ensure that you capture the maximum value available under federal tax law through tax-exempt bond financing and the refundable ITC program.

The preceding is a brief overview of refundable ITCs provided by the Inflation Reduction Act of 2022.  Please contact the authors or any other member of Hinckley Allen’s Tax and Public Finance Groups if you would like more information about refundable ITCs or any other current or future tax law development that may affect access to tax-exempt bond financing, or if you have any other tax-exempt bond matter you would like to discuss.

[1] Inflation Reduction Act of 2022, H.R. 5376, 117th Cong. (2022).

[2] Section 6417 of the Internal Revenue Code.

[3] If the taxpayer does have any federal income tax liability (e.g., for unrelated business taxable income), the tax credit will offset the liability. If the credit is greater than the liability, the difference will be paid in cash to the taxpayer.

[4] The Act also makes certain energy production tax credits, including those provided in Section 45 of the Internal Revenue Code, refundable to State and local governments and other tax-exempt entities including 501(c)(3) organizations, typically for larger-scale clean energy generation projects.

[5] Section 48 of the Internal Revenue Code.