The Inflation Reduction Act (IRA) provides a variety of incentives for clean energy. Many of these tax credits and rebates are aimed at individuals and households to transform their energy use and consumption – from home energy efficiency improvements to rooftop solar and electric vehicles. Local leaders have an important role to play in helping their residents understand and take advantage of these opportunities.

For the first time, however, local governments are positioned to take advantage of these tax credits directly. The IRA includes a provision that provides non-taxable entities investing in and producing clean energy with a direct payment option in lieu of tax credits. This provision is applicable for tax years starting after December 31, 2022 and ending before January 1, 2033. A project that is under construction now could potentially qualify. 

What is Direct Pay? 

Under the IRA, direct pay applies to states, cities and local municipalities, tribes and other tax-exempt entities, such as municipal water or power utilities and school districts. For city leaders, direct pay is an option for funding city-owned clean energy projects that will make projects more affordable for local governments and level the playing field between local governments and the private sector, which has traditionally benefited from tax credits.  

Of particular note for local governments, in order to claim the full direct pay amount, projects must meet the prevailing wage and apprenticeship requirements. The U.S. Department of the Treasury recently released guidance on these key labor provisions under the IRA. 

Additionally, there are specific criteria that when met will boost the value of the direct payment. For example, this includes projects with sufficient domestic content, projects that are located in “energy communities” (which include sites with brownfield properties, high unemployment or a closed coal mine or coal plant), projects in low-income communities, and rooftop solar projects on affordable housing. These opportunities can provide a 10-30% increase in the value of the direct payment depending on the criteria.  

Importantly, as cities, towns and villages look to take advantage of the grant funding provided under the Bipartisan Infrastructure Law and IRA, there is no prohibition on using direct pay and federal or state grant money for the same project.  

What Programs are Eligible for Direct Pay? 

Tax exempt entities, including state and local governments, can take advantage of the direct pay option under a variety of tax credits for both the production of and investment in clean energy. The Production Tax Credit (PTC) provides an ongoing tax credit for the first ten years of a project based on the amount of renewable energy produced in each year and sold to an unrelated person. The Investment Tax Credit (ITC) are one-time tax credits based on a percentage of the qualifying costs of a project.  

The IRA includes the following new and expanded tax credits that are eligible for the direct pay option: 

This blog provides more details on each of these tax credits. The U.S. Department of the Treasury is currently developing guidance for implementing each of these tax credits and the process for local governments to receive the direct payment in lieu of tax credit. The guidance is expected to be finalized over the next year.  

Clean Energy Projects for Local Governments 

The climate and clean energy provisions in the IRA will incentivize a large shift toward clean energy and reducing greenhouse gas emissions. Here are three local examples from municipal water and power utilities undertaking clean energy projects that are likely eligible for tax exempt entities to take advantage of the direct pay option.  

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