Legal Updates

The Inflation Reduction Act, signed into law last week, has created two new mechanisms for monetizing new and existing energy tax credits, which may lead to significant cost savings and eliminate the need for complicated tax equity structures for renewable energy project owners.

First, in addition to traditional tax equity, the Act has created a "direct pay" mechanism for tax-exempt taxpayers, allowing them to elect to take a cash refund for the value of tax credits on eligible projects, even if the taxpayer does not have sufficient tax liability to claim the credit. Companies with limited tax liability can also use this mechanism for credits related to carbon sequestration, clean hydrogen and advanced manufacturing of certain renewable components.

The Act has also created a credit transfer mechanism whereby taxpayers can sell all or part of their credits to third parties. There are limitations to this provision; for example, the sale must be for cash and may incur penalties should the claimed credit amount be excessive.

These new monetization mechanisms may have significant impacts, particularly on tax-exempt entities, such as public power utilities, tribal governments and nonprofit organizations, that do not pay federal income taxes and could not use the renewable energy incentives for their own projects. Furthermore, these new mechanisms eliminate the need for complex tax equity financing arrangements (such as partnership flip agreements or inverted leases with developers) to claim available tax incentives.

While these new mechanisms may be a game-changer for both taxable and tax-exempt entities in the renewable energy industry, it is unclear what limitations or qualifications will be imposed by the Internal Revenue Service for direct pay eligible projects. Connell Foley will continue to monitor the development of these rules and/or limitations and their impact on the industry.