What instrumentalities need to know about the Inflation Reduction Act

Update June 2023: The Internal Revenue Service (IRS) and Department of the Treasury (Treasury) recently released proposed and temporary regulations, and issued a set of frequently asked questions covering the direct payment option available for certain taxpayers (applicable entities) to monetize energy credits under the Inflation Reduction Act (IRA). Key takeaways include:

• The regulation clarifies agencies and instrumentalities are included in the definition of applicable entities (which also include tax-exempt organizations, state and local governments, the Tennessee Valley Authority, Indian Tribal governments, Alaska native corporations and certain rural electric cooperatives).
• The temporary regulations implement a pre-filing registration process for applicable entities before they can make a direct pay election. More details on the pre-filing registration process are expected to be released.
• The proposed regulations provide that partnerships are not applicable entities eligible to make a direct pay election. If an applicable entity owns property directly, either wholly or through an undivided ownership such as a tenancy in common, the applicable entity can make a direct pay election with regards to the property it owns. Further, in a sale/leaseback situation, the owner of the property would be the one that can take advantage of direct pay or the option of transferability of the credit to another party.

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The Inflation Reduction Act of 2022 (IRA) is the largest energy incentive effort in U.S. history, creating an environment where many energy-related projects are significantly more attractive and easier to fund. The credits offered through IRA represent a financial offset for qualified construction or production costs. The credits start at a base level amount and can be significantly increased if a project employs apprentices and pays prevailing wages.

Certain tax exempt and governmental entities were previously not able to directly take advantage of prior tax incentives for clean energy projects. The IRA added IRC §6417 to allow direct pay provisions for several of the clean energy incentives. State or political subdivisions, tax exempt entities, and Indian Tribal governments, along with others, are now eligible to receive direct pay for IRA incentives. Only entities defined as applicable entities under §6417 are eligible for the direct pay provisions. Instrumentalities are specifically referenced in the IRA under other amendments but were excluded from the definition of an applicable (meaning eligible) entity under the §6417 provisions. This leaves instrumentalities unclear whether they were intentionally left out of the direct pay provision in the IRA or if it was an oversight. Clarification is currently being sought by several associations typically classified as instrumentalities.