The Inflation Reduction Act (IRA) of 2022 has introduced several new and improved energy tax credits that can significantly benefit tax-exempt organizations. These credits are designed to stimulate and upscale the U.S.-based energy economy. The unique feature of these credits is their refundability, which means that even tax-exempt organizations that don’t normally pay federal tax may qualify for cash refunds based on their compliance with the credit rules.
Energy tax credits available under the IRA
The IRA has revised some existing credits and created new ones with a focus on supporting clean energy facilities in the United States. These credits range from 6% to 40% of qualifying clean-energy investments but can even reach as high as 50% of the costs if certain requirements are met.
Investment tax credits have been expanded to include qualified energy property or technology either constructed or acquired for original use.
Qualified energy resources include:
- Wind & solar
- Closed- & open-loop biomass
- Geothermal
- Small irrigation power
- Municipal solid waste
- Qualified hydropower production
- Marine & hydrokinetic renewable energy
The investment tax credits do not apply to the installation of energy efficient projects that simply reduce the total annual energy consumption using existing resources, such as more efficient interior lighting/HVAC/hot water systems, or other improvements in the building that conserve energy but do not alter the energy type used by the facility.
The Energy-Efficient Commercial Building Deduction provides a deduction for energy-efficient commercial buildings property for improvements to interior lighting, heating, cooling, ventilation, hot water systems, and building envelope (i.e., roof, walls, doors, windows), and installed as part of a plan designed to reduce a building’s total annual and power costs. While this deduction isn’t new, tax-exempt organizations can now benefit by potentially negotiating lower project costs by allocating the deduction to the designer of the property (i.e., architects, engineers).
It has also introduced carbon sequestration tax credits that reward entities for implementing systems that capture, store, and/or utilize carbon.
Clean vehicle tax credits provide tax benefits for those who add electric and other clean-energy vehicles to their fleets, as well as those who build infrastructure to support these vehicles such as alternative fuel refueling sites or charging stations. The installation of EV charging stations must be in a low-income or nonurban location to qualify.
Claiming IRA energy credits: Who benefits?
Tax-exempt organizations stand to benefit from claiming the credit, including:
- Public & private higher education institutions
- K-12 schools
- Hospitals & health systems
- Museums & zoos
- Animal shelters
- Social welfare organizations
- Unions
- Reinvestment & development initiatives
- State & local governmental units/cooperatives
Best practices for claiming an IRA energy tax credit
An important aspect of these credits is that they’re now available to organizations that have never filed a federal income tax return in the past. As such, it’s greatly important to understand how to be successful in claiming the credits.
- Pay close attention to the timeline. To claim a refund, entities must make a valid direct pay election on a timely filed return, including extensions. Exempt organizations will make this election on Form 990-T, which is due five and one-half months after an organization’s year-end. Many tax-exempt organizations may not have been required to file Form 990-T in the past and as such, aren’t in the habit of filing this tax return. If an organization doesn’t file its tax return by the initial due date and fails to file an extension, it’s disqualified from making an election and cannot claim a refund.
- Complete your prefiling registration as soon as possible. To obtain a refund, exempt organizations must include with their tax filing a registration number for each property tax for which they are claiming a credit. Registration is completed with the Internal Revenue Service via an online registration portal. The IRS recommends that organizations register their qualifying projects at least four months before filing the return on which the credits will be claimed. Organizations don’t need to provide any credit amounts or computations during this process. Instead, the focus is to verify an organization’s identity and confirm proof of ownership and date the property was placed in service.
- Consider forming a committee with representatives from operations and facilities; finance and accounting; engineering firms; and contractors to facilitate communication. The process will require input from different teams at different points throughout, including identifying qualifying projects, gathering and maintaining appropriate documentation needed for enhanced credits, computing credit calculations, completing prefiling registration, and filing tax extensions and returns.
- Discuss documentation needs and prevailing wage and apprenticeship requirements with contractors upfront and consider updating your contracts to require adherence to these requirements.
- Engage a cost segregation study from the start. Depending on the size and scope of a project, not every cost associated with a project will qualify for a credit. The more an organization invests upfront in accurately classifying and documenting the costs of a project, the smoother the process of preparing a claim for the credit and responding to any IRS challenges will go.
While there are plenty of potential pitfalls that organizations need to recognize and avoid, the potential upside here is significant. These credits can provide a valuable source of funds for projects that can reduce an organization’s cost and lower the impact of its operations on the environment.
