ITC Direct Pay will Change the Solar Game

Posted 10/27/2022 in Solar News

Inflation Reduction Act – Direct Pay is a Game Changer   

On Tuesday, August 16, 2022, President Biden signed the Inflation Reduction Act (IRA) into law.  The IRA covers many topics including heavily incentivizing renewable energy generation as well as electric vehicles. While many of these incentive changes will kickstart a new wave of the “solar-coaster”, the addition of Direct Pay for tax-exempt entities to utilize the Investment Tax Credit (ITC) may have the biggest impact on the solar industry.

Inflation Reduction Act Direct Payment

The IRA introduced a new concept to the ITC structure by offering the option for direct payment to tax-exempt entities. According to the National Law Review, eligible entities for direct payment are as follows:

  • Federal Government Tax-exempt organizations
  • State and Local Governments
  • Indian Tribes
  • Tennessee Valley Authority
  • Alaska Native Corporation

Universities and colleges are eligible for the direct payment option via federal government tax-exempt organizations. However, not all universities and colleges may be eligible. According to the National Association of College and University Business Officers (NACUBO) universities and colleges that are considered tax-exempt under section 501(c)(3) of the Internal Revenue Code are eligible. This means if a university or college is classified as an “instrumentality of the state” instead of a “political subdivision” or an “integral part of the state” they will not qualify for direct payment. Zapotec recommends that each university or college 501(c)(3) status be investigated case-by-case.

It should also be noted that direct payments for the ITC must be taken by a partnership or S corporation and cannot be claimed by a partnership’s or S corporation’s shareholders.

Domestic Content and other requirements

To fully take advantage of the direct payment option, tax-exempt entities will want their systems to remain less than one megawatt (MW). If they are larger than a megawatt the system and the direct payment will be subject to several other requirements including using prevailing wage labor. Additionally, even if the system is less than one megawatt it will be required to meet the domestic content requirement. This means one hundred percent of the steel and iron used in the PV system must be considered domestic content. The remaining equipment used in the system must be a set percentage of domestic content that is on an increasing scale as time progresses, as outlined in Table 1. In 2024 and 2025 if the Domestic Content requirement is not met, a percentage of the direct payment will still be granted, however in 2026 domestic content is required for any eligibility of direct payment.

Table 1: Domestic Content Requirement for Direct Payment ITC Eligibility 

Direct Payment Industry Effect

Prior to the IFA, tax-exempt entities only had one option if they wanted to take advantage of the previous ITC structure. Third-party ownership was the most common way to utilize the ITC and this approach was typically done via a power purchase agreement (PPA) (Figure 1). A PPA typically has a third-party taxable entity come in and own the PV system as well as pay for the system installation and maintenance of the system throughout its life. The tax-exempt entity would lease its roof or ground space to the PPA provider and in return receive a discount on their electricity for the energy produced by the PV array ranging from ten to twenty percent of the market rate. There are some disadvantages of a PPA for tax-exempt entities, the main two being that the tax-exempt entity does not control the array and has no ownership over it and that the tax-exempt entity would miss out on Solar Massachusetts Renewable Target (SMART) incentive payments that would be paid to the system owner, the PPA provider. It is also worth noting that a PPA may not be the best option from a financial standpoint when compared to a direct payment option, each scenario should be analyzed to determine the best option.

Figure 1: Flow Chart of Tax-Exempt Entities pursuing Solar Before and After Direct Pay

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