The Inflation Reduction Act, enacted in 2022, provides a groundbreaking framework for advancing clean energy initiatives across the United States. This legislation’s primary focus is to incentivize energy-efficient investments through tax credits, including provisions that allow local governmental agencies and other tax-exempt entities to benefit from these incentives via elective pay, also referred to as direct pay. By tapping into these opportunities, local governments can significantly reduce costs while advancing sustainability goals, modernizing infrastructure, and stimulating local economies.

Traditionally, tax credits have been of limited use to local governments and tax-exempt organizations, as these entities do not pay federal income taxes. The Inflation Reduction Act addresses this limitation by introducing the concept of elective pay. Elective pay allows eligible entities, including state and local governments, to receive direct payments equivalent to the value of certain federal tax credits, effectively transforming these credits into cash subsidies.

For local governments, this means that investments in energy-efficient infrastructure, such as renewable energy systems, electric vehicles (EV), and energy-efficient building upgrades, can be partially offset through federal support. This provision dramatically enhances the feasibility of ambitious sustainability projects that may have been previously out of reach due to budgetary constraints.

To access tax credits under the elective pay mechanism, local governments must adhere to the following structured process:

Determine Eligibility

Local governments should first confirm their eligibility to receive elective pay for the specific tax credits they plan to claim. This involves identifying qualifying projects, such as renewable energy installations, energy-efficient building upgrades, or electric vehicle purchases.

File Form 990-T

Although local governments are generally tax-exempt, they must file Form 990-T, Exempt Organization Business Income Tax Return, to claim the elective pay. This form includes schedules for reporting qualifying energy projects and requesting direct payments.

Complete Applicable Tax Credit Forms

Along with Form 990-T, local governments must submit the specific forms associated with the desired tax credits, such as:

• Form 3468: Investment Credit, for renewable energy projects.
• Form 8911: Alternative Fuel Vehicle Refueling Property Credit, for EV charging infrastructure.
• Form 8936: Qualified Plug-in Electric Drive Motor Vehicle Credit, for electric vehicle acquisitions.

Maintain Detailed Documentation

Accurate records of project costs, energy savings, and environmental benefits are essential to substantiate the credit claims. This documentation should align with the requirements outlined by the IRS.

Submit Forms to the IRS

Once all required forms and documentation are complete, they must be submitted to the IRS for review. Local governments have the option to submit these forms electronically via the IRS e-file system or by traditional paper filing, though e-filing is recommended for its speed and accuracy. Local governments should ensure compliance with deadlines and other filing requirements to avoid delays or denials.

Receive Direct Payment

Upon approval, the IRS will issue a direct payment to the local government equivalent to the value of the tax credits claimed. Typically, these funds are disbursed electronically via ACH (Automated Clearing House) for speed and efficiency. However, if electronic banking details are not provided or there are issues with the transfer, the IRS may issue a paper check. Local governments should confirm their preferred payment method on the appropriate forms to ensure timely receipt of funds.

Local governments can capitalize on several tax credit opportunities under the Inflation Reduction Act, such as the following:

Renewable Energy Projects

The Inflation Reduction Act extends and expands the Investment Tax Credit and Production Tax Credit for renewable energy projects, including solar, wind, geothermal, and hydropower installations. With elective pay, local governments can directly receive the monetary value of these credits, enabling the development of:

• Solar farms on municipal land to power government facilities and schools.
• Wind energy projects to diversify local energy sources.
• Geothermal heating and cooling systems for public buildings.

The Investment Tax Credit typically offers a credit of 30% of the project's eligible costs. This means that a municipal solar installation with an eligible cost of $1 million could potentially yield a credit of approximately $300,000, while smaller-scale projects might secure credits ranging from tens of thousands to several hundred thousand dollars, depending on the scale and size of the eligible project. By leveraging these credits, local governments can reduce utility costs, decrease reliance on fossil fuels, and contribute to the transition toward a clean energy economy.

Energy-Efficient Building Upgrades

The Inflation Reduction Act incentivizes energy-efficient building upgrades through the Energy-Efficient Commercial Buildings Deduction (Section 179D). While initially aimed at taxable entities, elective pay allows local governments to benefit from these deductions as direct payments.

Under elective pay, local governments can claim a monetary equivalent of the Section 179D deduction by improving energy efficiency in public buildings. Eligible projects include lighting upgrades, HVAC system enhancements, and better insulation. These improvements not only reduce operational costs but also help municipalities meet energy-saving targets. Elective pay ensures that these benefits are accessible, even though local governments do not directly pay taxes, effectively transforming the deduction into a financial subsidy.

Electric Vehicle Adoption

The Inflation Reduction Act expands tax credits for electric vehicles, including commercial and heavy-duty EVs, making them more accessible to municipal fleets. Through elective pay, local governments can offset the cost of:

• Electric buses for public transit systems.
• EVs for municipal services such as waste collection and maintenance.
• Charging infrastructure to support the growing adoption of EVs.

Tax credits for EV acquisitions amount up to $7,500 per light-duty vehicle (vehicles less than 14,000 lbs.), while heavy-duty vehicles (vehicles over 14,000 lbs.), such as electric buses or trucks, can qualify for credits of up to $40,000 per vehicle. Additionally, investments in EV charging infrastructure could result in credits up to $30,000, depending on the scale of the project. Transitioning to electric fleets not only reduces greenhouse gas emissions but also decreases fuel and maintenance expenses over time, creating long-term financial and environmental benefits.

Energy Storage and Grid Resilience

Investments in energy storage technologies, such as battery systems, are also eligible for tax credits under the Inflation Reduction Act. These systems can store excess renewable energy generated during peak production periods and release it during high-demand times, enhancing grid resilience and reliability. For local governments, integrating energy storage with renewable energy projects can ensure uninterrupted power supply for critical facilities, including emergency shelters, hospitals, and water treatment plants.

In conclusion, the Inflation Reduction Act offers a transformative opportunity for local governments to advance their sustainability agendas while addressing pressing infrastructure needs. Through the innovative elective pay mechanism, local governments can unlock the value of tax credits previously unavailable to them, reducing the financial barriers to implementing energy-efficient solutions. With careful planning, compliance, and execution, local governments can harness the full potential of the Inflation Reduction Act to create lasting environmental, economic, and social benefits for their communities.

Nicholas Hennessy, CPA, is a manager at R.S. Abrams & Co., LLP. He graduated from Baruch College with a bachelor of business administration and has six years of auditing experience with R.S. Abrams & Co., LLP. Prior to joining the firm, he worked with Gould, Kobrick & Schlapp P.C. auditing labor unions and not-for-profits. He specializes in tax and audits of local governments.