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The U.S. Department of the Treasury and the Internal Revenue Service (IRS) released final rules on elective pay (otherwise known as “direct pay”).

Elective pay is an important mechanism in the Inflation Reduction Act (IRA) that helps enable state, local, and Tribal governments; non-profit organizations; Puerto Rico and other U.S. territories; and other entities to take advantage of clean energy tax credits. Treasury’s elective pay final rules provide certainty for applicable entities to understand the law’s scope and requirements for eligibility. 

Some highlights of the final regulations include:

  • Definition of “applicable entity”
  • Pre-filing registration process
  • Determining tax year for entities that do not have a Federal income tax or Form 990 filing obligation
  • Special rule on tax-exempt grants and forgivable loans
  • Applicable entities that co-own electricity-producing applicable credit property

What is elective pay?

Elective pay allows applicable entities, including tax-exempt and governmental entities that would otherwise be unable to claim certain credits because they do not owe federal income tax, to benefit from some clean energy tax credits. By choosing this election, the amount of the credit is treated as a payment of tax and any overpayment will result in a refund.

States, political subdivisions and their agencies are all eligible for elective pay. It also includes cities, counties and other political subdivisions.  Water districts, school districts, economic development agencies, public universities and hospitals that are agencies and instrumentalities of states or political subdivisions are also included.

How do local governments make the elective pay election?

  1. Identify and pursue the qualifying project or activity: You will need to know what applicable credit you intend to earn and use elective pay for. List of eligible projects/activities.
  2. Determine your tax year, if not already known: Your tax year will determine the due date for your tax return. 
  3. Placed in service: The applicable credit property must be placed in service BEFORE a registration number will be issued.*
  4. Complete the pre-registration process here, no earlier than the beginning of the tax year in which the credit will be earned. An EIN or TIN is required to complete the pre-filing registration process. Electronic return filing is strongly encouraged. A complete guide to the process can be found here.
  5. Satisfy all eligibility requirements for the given tax credit and any applicable bonus credits, if applicable, for a given tax year: You will need the documentation necessary to properly substantiate any underlying tax credit, including if bonus amounts increased the credit. 
  6. File Form 990-T by the due date (or extended due date) and make a valid elective payment election.  

*Placed-in-service is the point in time when a property or long-term asset is first placed in use for the purpose of accounting, primarily to calculate depreciation or grant a tax credit

Check out the following elective pay resources: