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Federal Regulators Clarify the Scope and Mechanics of “Direct Pay” and Hydrogen Tax Credits

on Tuesday, 12 March 2024 in Dirt Alert: David C. Levy, Editor

The U.S. Department of the Treasury (“Treasury”) and Internal Revenue Service (the “IRS”) recently clarified the scope of certain clean energy tax credits.  Regulations address (1) political subdivisions’ eligibility for “direct pay” of tax credits here and (2) qualifications for the clean hydrogen tax credit here.

Direct Pay of Tax Credits

“Direct pay” allows tax-exempt entities to access clean energy tax incentives.  Those incentives include tax credits for clean hydrogen production, production and investments in renewable energy projects, sustainable aviation fuel production and carbon sequestration.  See 26 U.S.C. §§ 45, 45V, 45Q & 48.

Traditionally, only taxpayers could access these incentives.  Nonprofit organizations and political subdivisions such as public power districts and municipalities are tax‑exempt.

In 2022, Congress added 26 U.S.C. section 6417.  It permits certain tax‑exempt entities to apply for and receive a “direct pay” equal to the amount of the credit.[1]

Final regulations now clarify the following about direct pay:

  1. Registration. Before claiming a direct-pay credit for any given property, tax-exempt entities must register with the IRS.  Registration is online, as is a user guide and instructional video.  To obtain a registration number in time, the IRS recommends registering at least 120 days before the deadline to claim a given credit.
  2. Form 990-T. To claim direct pay, tax-exempt entities must file (i) IRS Form 990-T: Exempt Organization Business Income Tax Return and (ii) Form 3800 – General Business Credit.  This is addition to any credit-specific forms (e.g., Form 8835: Renewable Electricity Production Credit).
  3. Tax Year. Tax-exempt entities should use the organization’s established accounting period.  That can be either a calendar or fiscal year.
  4. Grants and Loans. Tax-exempt entities may receive direct pay for a project even if the project received funding through a grant or loan.  Put differently, the grant or loan does not reduce the amount of direct pay.

Hydrogen Tax Credit

Congress also adopted the hydrogen credit in 2022.  See 26 U.S.C. § 45V.  The IRS proposed tax guidance for the credit in December 2023.  We analyzed that guidance in this article

Reports have since emerged about the U.S. Department of Energy (“DOE”) pushing for relaxed regulations.  Specifically, DOE’s concern is with the proposed “incrementality” requirement.  It would require hydrogen producers to use new low‑carbon electricity sources like wind or solar farms.

DOE and various public commenters, by contrast, have advocated for Treasury and the IRS to loosen that requirement.  Commenters to permit hydrogen producers to offtake electricity from other sources.  This may potentially permit electricity from the grid, which includes generation from fossil fuels.

The comment period for this proposed regulation closed on February 26, 2024.  Treasury and the IRS will next hold a public hearing on March 18, 2024.  Final regulations will likely follow later this year.

Attorneys at Baird Holm LLP have experience assisting clients with these matters.  If you have any questions about these proposed regulations or would like to discuss the potential eligibility of your entity, please contact the firm.

[1] We previously analyzed direct-pay eligibility in this article.

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