Final Municipal Tax Credit Regulations Present Opportunities for Clean Energy Projects

By:

Michael Gleeson
Carolyn Berndt

April 24, 2024 - (5 min read)

In March, the U.S. Department of the Treasury and Internal Revenue Service (IRS) published final regulations for the Inflation Reduction Act elective pay program, also known as direct pay, that provides tax incentives to municipalities for installing a variety of clean energy projects.

Since the initial guidance was published last year, NLC hosted focus groups with members to inform our comments to Treasury and the IRS on what municipalities need to see in these rules to make them work. We are pleased to see much of our feedback incorporated into the final rule, which will make it easier for local governments to take advantage of the tax credits and clean energy projects in communities that help meet local climate action goals. The final regulations incorporate much of our feedback.

This blog breaks down the final regulations into things municipalities should know, key wins, and remaining challenges for municipalities as they move forward with implementing elective pay programs in their communities.

What Municipalities Should Know

Filing requirements: Municipalities that do not typically file a tax return will use Form 990-T. The election must be made on a timely filed tax return, including extensions. Amended returns or administrative adjustment requests (AAR) can be used to correct erroneous amounts claimed, but municipalities cannot file an original return with blanks in order to get the refund rolling and then file an amended return/AAR to fill in the blanks.

Pre-registration requirements: Pre-registration on the IRS portal is required in order to receive the elective payment. Registration is required every year. The registration number must be filed with the tax return, electing elective pay, or the IRS won’t pay it. The regulation preamble encourages filing for registration at least 120 days before filing the tax return to give the IRS time to process the submission.

For example, a city that has a tax year that ends on June 30 would have to file a tax return by the 15th day of the 5th month after the end of the tax year. This would mean the return would be due November 15, and pre-filing would need to be made at least 120 days before that.

Property Placed in Service: A registration number cannot be applied for until the property has been “placed in service,” as defined in tax law. Consult your counsel to make sure your municipality understands this term for purposes of claiming the credit.

Registration, not a guarantee: Being granted a registration number is not a guarantee that the credit is allowed or properly computed. This is the first step in the process of receiving elective pay, but it is not a guarantee. Keep this in mind as your municipality plans its projects.

Key Wins

Your money: The regulations make it clear that the refund from elective pay is the city’s money. A municipality could buy down the principal on a loan used to finance a project, use the money as a grant match for the next project, and deposit it in its general fund, among other uses. The fact that local governments determine the use for the payment is key. NLC did not directly advocate for this, but we assumed this to be the case and are happy Treasury clarified it.

Overpayment reform: Overpayments by the IRS to a municipality, for example, misstating the credit amount owed to the municipality, is known in this context as an “excessive payment.” Under the initial guidance, a municipality would have had to pay the excessive amount back plus 20 percent. In the final regulations, the 20 percent can be waived if reasonable cause (using established criteria in tax law and doctrine) can be demonstrated. Allowing this to be waived by reasonable cause is something NLC pushed for in our comments and is a great win.

Remaining Challenges

Tax oversight: Municipalities will be subject to the same tax examination procedures as regular taxpayers. This means that all municipalities that undertake a project will need to keep good books and records for years. NLC has seen cases with the State and Local Fiscal Recovery Funds (SLFRF) where some municipalities did not keep good records. This will be critical in case an audit comes up.

Labor intensive: One of the things NLC learned from the SLFRF experience is the municipal staff are stretched thin. A direct pay election is made for each applicable credit property. If your municipality has a fleet of 50 EVs, you will need the VINs off every EV and track them through their life cycle of phasing out of the fleet and being replaced. If your municipality has solar on municipal buildings, they will have to note all the different cells. This will be labor intensive for cities that might not have extra capacity.

Upfront costs: Elective pay works with a municipality advancing the money for a project and then a reimbursement in the form of a tax refund is issued. Treasury and the IRS declined to provide any timeframes in which they must process tax returns electing direct pay. Municipalities hoping to quickly turn around their refund and get a return on their investment might have to wait.

Remedy unclear: In the same line, a municipality will make an investment with the hopes of getting a tax credit to help offset the costs. The IRS and Treasury are vague in the regulations on how and whether a municipality can appeal a denial of a direct pay claim.

Going Forward This blog is meant to provide city leaders with the starting blocks for assessing projects in light of the final elective pay regulations. NLC will be providing additional blogs and webinars in the coming weeks to help local leaders as they navigate this new world of taxes, tax elections and tax credits. Stay tuned as we dive into specific topics such as building capacity, stacking funding and financing, and avoiding potential foot faults.