Historically, energy projects have often produced more tax credits than sponsors have the ability to use. This has required sponsors to undergo a significant effort to syndicate the credits, which generally means finding investors with the right tax appetite that will invest in a project in exchange for a financial return that includes tax benefits. Syndication also often requires complex maneuvering to allocate tax credits as intended, while allowing sponsors to retain current and future rights to the projects. Additionally, agreements for tax credit syndication have to meet stringent rules in the Internal Revenue Code and from other related guidance for allocations and economic performance. These issues and complexities increased the risk of credit syndication and drove down the value of credits to third parties due to transaction costs — ultimately reducing capital available to sponsors to complete their energy projects.
As part of the revamped energy tax credit program under the Inflation Reduction Act of 2022 (IRA) for tax years beginning after December 31, 2022, sponsors and other owners now have two new potential avenues for monetizing tax credits generated by their projects: direct pay and transferability. While each of these options have their own stipulations, they are extremely valuable tools for sponsors looking to monetize tax credits. In addition, the rules should allow investors to acquire tax credits using simpler transaction structures, thus potentially creating a wider market of investors looking to acquire tax credits.
Direct Pay Under Section 6417 of the Inflation Reduction Act
As a credit against income tax, energy tax credits have a history of only providing value to potential investors with an income tax liability. As a result, tax-exempt organizations, specifically, lack the ability to benefit from standard energy tax credits. Section 6417 of the IRA provides a new mechanism for these types of investors to benefit from credits in the form of an elective payment option, or direct pay.
