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September 14, 2023
In February 2023, St. Patrick’s Episcopal Church located near Atlanta, Georgia, installed a 90-panel, 42-kilowatt rooftop solar system, which would normally be eligible for a 30 percent clean energy tax credit. But as a tax-exempt nonprofit, St Patrick's does not pay taxes, so a credit would be of no use to it. Fortunately, the Inflation Reduction Act of 2022 (P.L. 117-169, IRA) gives tax-exempt entities equal access to clean energy incentives by introducing the direct pay (a.k.a. elective pay) option. This allows qualifying tax-exempt entities to receive a direct payment from the Internal Revenue Service (IRS), in lieu of a tax credit.
On June 14, the IRS issued guidance on direct pay/elective pay for clean energy tax credits (e.g., tax credits for solar, battery storage, and geothermal heat pumps) for tax-exempt organizations. Qualified entities installing eligible clean energy upgrades can benefit from direct pay/elective pay if they have “placed into service” such upgrades after January 1, 2023. The direct pay option will help state and local governments, nonprofit organizations, rural electric cooperatives, public power entities, schools, and tribal entities access clean energy tax credits. Thanks to this new option, nonprofits, including houses of worship, theaters, libraries, animal shelters, community health centers, and museums, can better afford clean energy upgrades. The resulting savings can be used to advance these nonprofits’ missions and expand services to disadvantaged communities.
The direct pay option is a game-changer because it gives nonprofits access to the same financial incentives that for-profit companies receive when investing in renewable energy. Most organizations and entities will be eligible for tax incentives of between 30 and 50 percent of the project's total cost, depending on the project's location and how much of the hardware content is produced domestically. Projects located in “energy communities” can receive an additional 10 percentage point incentive, and those that use domestically-sourced materials can claim an extra 10 percentage points bonus. Altogether, tax-exempt entities installing clean energy systems in energy community-designated census tracts and low-income residential buildings may receive up to 70 percent of their renewable energy project's costs.
Before the IRA, entities that had no tax liability could not access federal clean energy tax credits for their projects. This resulted in nonprofits leaving money on the table and devoting more resources to projects than for-profit companies, which could benefit from tax credits. There were workarounds, such as transferring tax credits to taxable entities, but these involved complex financial setups.
Many nonprofits would lease or install their solar panels through a power purchasing agreement (PPA) with a tax-liable third party that would take on the tax credits. The third party, typically a tax-equity investor, would purchase and install the solar panels on the nonprofit’s facility. The nonprofit would buy the energy generated from the solar panels, usually at lower rates than those charged by power utilities. The nonprofit would not own the solar system. With the IRA signed into law, nonprofits have a simpler pathway to install clean energy systems, receive tax incentives, and own their systems—all at a lower cost.
Under the IRA, the existing clean energy tax credits, the Investment Tax Credit (ITC), and the Renewable Energy Production Tax Credit (PTC) are modified and expanded through 2032. The ITC is a tax credit that reduces tax liability by a determined amount (e.g., 30 percent of the total cost of a solar system) and is a lump sum, one-off credit. The PTC is a per kilowatt-hour (kWh) tax credit for electricity generated by wind energy and other qualifying technologies (including solar) for the first 10 years of a system's operation. If the IRA had not been signed into law on August 16, 2022, both tax credits would have dropped to 22 percent this year and to 10 percent by 2024. The IRA also expands ITC to include standalone battery storage devices for residential and commercial entities. Wind energy and geothermal heat pumps can also claim the ITC credit.
From the years 2023 to 2032, tax-exempt entities can claim direct pay tax incentives when installing a clean energy project in their properties. Eligible technologies for direct pay can be grouped into three categories:
On-site clean energy systems can lead to lower energy and maintenance costs. The money saved can be used to develop “disadvantaged communities.” With increased climate change impacts, solar and battery storage offers resilience and a reliable source of backup power to nonprofits when the electricity goes out in cases of extreme weather.
With the IRA making it easier for nonprofits and government entities to claim clean energy tax credits, demand for clean energy technologies is expected to skyrocket. The Congressional Budget Office, a government watchdog agency, estimates that the clean energy tax credits will cost the federal government about $391 billion over their lifetime. Other organizations, such as the Brookings Institute, put the price tag at up to $1.1 trillion through 2032. On the flip side, this means that the clean energy tax incentives, including direct pay for distributed generation, will spur more than $3 trillion in investments in clean energy for the next decade. In turn, this implies a rise in well-paying domestic jobs, lower energy bills for families and businesses, and decreased greenhouse gas emissions.
For St. Patrick’s Episcopal Church, the journey to installing solar panels started in 2010 with an energy audit supported by two local nonprofit organizations, Georgia Interfaith Power and Light and the Southface Institute. The audit determined the church would save money by installing solar panels. In 2020, the ministry finally approved the $105,000 project. “We wanted to install solar panels to be more energy efficient and to help us power our church buildings and our food pantry,” said Rosalie Hopkins, Chair of the Buildings and Grounds Committee at St. Patrick's Episcopal Church. “The fact that we can now claim the clean energy tax credits through 'direct pay' because we placed in service the solar panels in 2023 is an added bonus that will help the church’s finances.”
The church runs a food pantry for the homeless, Malachi’s Storehouse, which feeds more than 4,500 people daily. The solar panels are now powering the pantry's freezers and coolers. Since being put into service in February 2023, the panels have generated 35.5 megawatt-hours (MWh) of clean energy, saving 53,000 pounds of carbon emissions. The panels help the church save 9,000 kWh monthly or about $5,000 in energy bills.
Though direct pay was not originally a factor in the church's decision to install solar panels, it certainly made the process more appealing. Thanks to the Inflation Reduction Act, the church can claim $30,000, or 30 percent of the total project costs, in incentives as a tax-exempt organization Because St. Patrick is not located in an energy community and its solar panels were not domestically produced, the church cannot claim the additional bonus credits; a 30 percent tax incentive is the maximum the church can request.
“St. Patrick’s Episcopal Church is looking to invest the direct pay proceedings in additional rooftop solar panels to save more energy and become a net-zero church,” said Hopkins.
Smaller tax-exempt entities similar to St. Patrick’s Episcopal Church are expected to primarily benefit from the direct pay tax incentives that significantly boost distributed energy installations such as solar and battery storage. When installing solar or battery storage systems, these entities can claim between 50 and 70 percent of their total costs as direct payments, depending on their location and the origin of the materials they use, or if they are in a low-income building.
Nonprofit organizations that install distributed energy resources can stack direct pay tax incentives with utility rebates and state grants to maximize clean energy affordability. Nonprofits can work with green banks, credit unions, and other community lenders to finance the portion of the project that tax incentives do not pay for. With more than $27 billion in federal funds available through the Greenhouse Gas Reduction Fund, green banks can offer low-cost financing for clean energy deployment, prioritizing investments in frontline communities.
The Inflation Reduction Act turned the clean energy tax credits into a formula rather than a straight tax credit. With the IRA, the 30 percent ITC for solar, geothermal, and battery storage projects becomes the “base credit.” For clean energy projects looking to claim the PTC on a kilowatt-hour (kWh) basis, the base credit under IRA is 2.75 cents per kWh. The IRA established additional bonus credits that can be stacked on top of the base credit if certain conditions are met. These bonuses are the “domestic content,” “energy community,” and “low-income community” bonus credits.
Small-sized energy projects—under one megawatt (MW) in capacity—do not need to meet specific prevailing wage and apprenticeship requirements that large-sized projects need to. This is particularly helpful for smaller nonprofits, like churches and schools, that tend to install small projects. This means that a nonprofit installing a clean energy system will at least receive the base credit of 30 percent through the ITC and 2.75 cents per kWh under the PTC.
With the ITC, to add an additional 10 percentage points to the base credit, projects must source at least 40 percent of their steel and iron products domestically. For solar arrays, this includes the steel photovoltaic module racking, inverters, PV tracker, and any steel or iron rebar used in the concrete pad foundation. Under the PTC, a tax-exempt organization receives 0.3 cents per kWh on top of the base credit if it meets domestic content requirements.
Clean energy projects sited in locations deemed “energy communities” under the Inflation Reduction Act can claim an additional 10 percentage points to the base ITC credit through the Energy Community Tax Credit Bonus. Under the PTC, they can receive an additional 0.3 cents per kWh in addition to the base credit. “Energy communities” are defined in three different ways:
The low-income community bonus credit is a program created under IRA to benefit clean energy projects sited in low-income communities, tribal communities, or as part of an affordable housing development. Administered by the Department of Energy (DOE) in partnership with the IRS, the low-income credit is capped at 1.8 gigawatts (GW) of clean energy capacity per year for 2023 and 2024 (the low-income tax credit program ends in 2024). One gigawatt is enough to power about 750,000 homes. Projects built in these communities may receive a credit worth an additional 10 percentage points and need to be limited to five megawatts or smaller in capacity. Distributed energy systems installed in low-income residential buildings or on their property can claim a 20-percentage point bonus (instead of the 10-percentage point bonus), provided the system generates enough energy to cover at least 50 percent of the building’s total energy needs.
To qualify for the low-income community bonus credit, applicants must submit information about their project to DOE by early fall 2023, when the program opens for the current year. DOE will review the applications and recommend which projects can receive bonus tax incentives, which are also eligible for direct pay. Awarded applications will have four years to complete project installation.
Direct pay tax incentives to tax-exempt organizations are not immediately available upon the purchase of eligible clean energy technologies. They are not set up as point-of-sale rebates. Instead, because these tax credits are coded into the Internal Revenue Code, they are administered by the IRS and the U.S. Department of the Treasury. Nonprofits need to file proper documentation with the IRS, as part of their tax returns, and wait until the next fiscal year to receive the incentives.
The entire process could take between four to 18 months, depending on when the eligible installation is put into service and when the nonprofit files for taxes the year following the project commencing operations. If the organization files for a tax extension, the process will take more time. Nonprofits and other tax-exempt entities must account for this long gap between outlays and credits when installing clean energy upgrades.
An organization eligible for a tax incentive will want to complete its clean energy installation as soon as possible, since the ITC (the most commonly used tax credit by nonprofits) is only earned the year the project is turned on (and only paid by the IRS the following year, when the organization's tax return is submitted and processed).
Once the project has been switched on, the organization must pre-file with the IRS to receive a registration number at the end of the calendar year during which the project was installed. Finally, the tax-exempt organization must submit its project documentation to the IRS along with its 990-T tax return form. The IRS will send the payments to the organization within 45 days. Author: Miguel Yañez-Barnuevo
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