Tax-exempt organizations have a new cash flow opportunity

While the Inflation Reduction Act (IRA) has ushered in a new era of tax incentives, many entities may not be able to benefit fully from the incentives due to their tax-exempt status or lack of taxable income. For such entities, the IRA offers an alternative option: electing to receive a direct payment (also known as elective payment) from the IRS, instead of claiming the tax credit. This option can provide a valuable source of cash flow and financing for these entities, but it also comes with complex rules and procedures that need to be followed carefully.

In this article, we will explore the final regulations issued by the IRS under section 6417 of the Internal Revenue Code, which govern the elective payment mechanism for applicable credits. We will focus on two important aspects of these regulations that affect tax-exempt organizations and grant recipients. Finally, we will provide practical guidance on how to comply with the requirements and maximize the benefits of the elective payment option.

Non-filing entities tax year

For tax-exempt entities that have not traditionally been required to file a return, the IRS has specified procedures to accommodate their situations. These entities can now make elective payment elections for clean energy projects. Specifically, if these entities undertake eligible projects, they may have to undergo a pre-filing registration process, despite their lack of a historical filing requirement.

Reg. §1.6417-2(b)(3) provides that such entities may determine their taxable year for filing Form 990-T based on either a calendar year or a fiscal year [1], thus offering flexibility and acknowledging the varied nature of tax-exempt organizations. The entities must maintain adequate books and records to support their chosen taxable year for making an elective payment election. The rule offers resolution for fiscal year taxpayers who placed in service credit-eligible property in early 2023 without needing to go through a complex and likely missed opportunity to change a tax year under the IRC section 441 procedure.

Grants and forgivable loans

The final IRA regulations provide guidance on the treatment of grants and restricted donations for clean energy projects. Tax-exempt amounts, including income from grants and forgivable loans used to acquire eligible clean energy projects, are included in the basis for computing the applicable credit amount. However, a "no excess benefit" rule reduces the credit if the sum of restricted tax-exempt amounts and the credit exceeds the property's cost. The rule applies to all restricted tax-exempt amounts, including federal and non-federal grants, to prevent entities from receiving inflated credit amounts. The regulations also address "recoverable grants," which may not be considered restricted tax-exempt amounts if repayment is only required when there's an excess benefit.

The determination of whether a tax-exempt grant is considered a restricted tax-exempt amount is made when the grant is awarded. Grants awarded after investment-related property has been purchased are not considered restricted tax-exempt amounts. Restricted tax-exempt amounts are specifically aimed for the purchase, construction, reconstruction or acquisition of investment-related credit property. However, grants awarded post-acquisition can be deemed restricted if the grant approval was merely a formality and the grant amount was almost guaranteed at the time of application.

Unrestricted gifts or general funds are addressed in section 1.6417-2(c)(3)(ii). The regulation specifies that the "no excess benefit" rule is inapplicable if the tax-exempt amount is not allocated “for the specific purpose of purchasing, constructing, reconstructing, erecting, or otherwise acquiring property eligible for an investment-related credit.” Finally, the pre-registration process mandates the disclosure of funding sources.

Final thoughts

The final regulations of section 6417 mark a crucial update for tax-exempt organizations, grant recipients and other entities aiming to leverage the full potential benefits of the IRA. While the final guidelines are new and intricate, they provide unique opportunities for alternative financing, especially for those managing grants. To successfully navigate these complexities, begin by consulting with one of our tax specialists.

Resource

1. Elective Payment of Applicable Credits; Elective Payment of Advanced Manufacturing Investment Credit; Final Rules; Election To Exclude Certain Unincorporated Organizations Owned by Applicable Entities From Application of the Rules on Partners and Partnerships; Proposed Rule, Federal Register, 2024