IRS Releases Guidance on Elective Payments

On Wednesday, June 14, 2023, the IRS released its long-awaited initial guidance and proposed regulations regarding the newly created direct payment election methodology. The federal government created this new “elective payment election” under the Inflation Reduction Act (IRA) to incentivize local governments and tax-exempt entities to construct and own clean energy-producing property. If your political subdivision or tax-exempt organization is planning to build a new facility, such as a new civic center, or rehabilitate an existing structure, like retrofitting City Hall or an ice rink, and will utilize clean energy assets to generate power for the new or retrofitted facility, that project may be eligible for this new direct payment subsidy provided by the federal government.

The initial guidance provides clarity regarding who must own the energy property to claim the credit, the process and instructions for filing the tax returns required to receive the elective payment, how to successfully elect to receive the elective payment, and how to make sure one receives the maximum amount of credit that its energy project is eligible for. This article will briefly summarize some of the most important pieces of this new guidance. A more in-depth analysis will follow in a sister article.

The IRS clarified that the entity electing to receive the elective payment must generally own the underlying clean energy asset. The IRS explained, however, that ownership can occur through various legal structures. An entity could own the asset through a disregarded entity or could “own an undivided interest in an ownership arrangement treated as a tenancy-in-common or pursuant to a joint operating arrangement that has properly elected out of subchapter K of chapter 1 of the Code (subchapter K) under section 761.”[1]

The IRS explained that five steps must be followed to make a successful elective payment election. Be warned, once an election is made, it is irrevocable. The first step is determining which type of elective payment-eligible credit your intended project will qualify for. The second step is to determine when your tax year ends. The end of your tax year will determine when you can file the required tax return for your elective payment. Please note that you cannot file your tax return until after your underlying energy project is placed into service. Third, you MUST complete the online pre-filing registration process with the IRS. During this registration process you will provide information about your entity, your project, and any tax credits you intend the project to earn.

Fourth, you must ensure that you have satisfied and properly documented all requirements to be eligible to receive the amount of credit you will apply for on your tax return. Failure to be able to substantiate that the amount of credit you claim was proper can be a costly mistake. Such a failure has the potential to drastically reduce the amount of credit your project is actually eligible to claim and could also result in costly penalties. Finally, you must timely file your annual return and all required ancillary documentation[2] by the due date or extended due date and make a valid elective payment election on said return.

The most illustrative part of the IRS’s initial guidance and proposed regulations discussed the creation of the pre-filing registration process and the associated requirements. In order to expedite the IRS’s review process for filed returns and to prevent improper overpayments, the IRS has created an online pre-registration portal. To be able to make an elective payment election, one must complete this registration process. Upon completion of the registration process, the IRS will issue a unique pre-filing registration number for each energy project that seeks to claim a tax credit and utilize the elective payment election. These registration numbers must be placed, where required, on your returns and paperwork to serve as identifying markings. The registration numbers must be renewed each year for projects that are not placed into service in the same year they were initially registered. The online portal and additional guidance on the pre-registration process will launch in late 2023.

The IRS clarified that utilizing grants, forgivable loans, or gap financing will not prohibit a project from being eligible for direct payments via the elective payment election. However, the IRS reiterated that utilizing tax-exempt bond financing will reduce the amount of the elective payment your project is eligible to claim by a maximum of 15%.

No entity is entitled to receive an elective payment until after the due date for the filing of its annual return has passed, even if one files its return before that due date but after the project is placed into service. An elective payment election can ONLY be made on an original and timely filed return, so it is imperative that you work with experienced professionals throughout the entire process to ensure you do not miss a deadline, miss a filing requirement, or fail to be able to substantiate the amount of the elective payment you believe you qualify for.