“Direct Pay” in the Inflation Reduction Act

The Inflation Reduction Act created many incentives for consumers and businesses to consume clean energy. Some of these provisions are in the form of tax credits that promote, among other things, the creation of electricity from renewable sources, investing in energy efficient property, and deploying clean energy facilities in low-income communities. 

If the tax credits are supposed to incentivize socially beneficial behavior, precluding tax-exempt organizations from availing themselves of the benefit might run counter to the reason for the provisions’ existence. Luckily (for the tax-exempt organizations, at least) the IRA made many of these credits eligible to tax-exempt organizations by way of “direct pay.”

“Direct pay” allows tax-exempt organizations to monetize these tax credits by treating them as an overpayment of taxes. The tax-exempt organizations are not required to have any income tax liability to use the credits, with the credit received as a cash payment in the year following the filing of the return.

There is some precedent for this:  certain employer-based credits, such as the Employee Retention Credit and the Work Opportunity Tax Credit, applied to tax-exempt as well as for-profit employers. The reasoning here is similar to that of the clean energy credits of the IRA — the rationale for the credit is unrelated to the tax-exempt status of the claimant. That is, employing a member of a disadvantaged group has social utility regardless of whether that employment is at a for-profit or a nonprofit.

What’s notable here are not the results–if we take it as a given that subsidizing clean energy (or employment) is important, it makes sense to subsidize it generally and without regard for the tax liability of the actor responsible.

What is most interesting (to me, anyway) is that “direct pay” makes explicit the extent to which social policy is deployed through the tax code. This has, of course, been happening for a long time, but there has typically been some connection to tax-based principles for the tax preference item in question. “Direct pay” is simply a check from the government to any taxpayer, without (in general) regard for distributional considerations or any connection to a taxable base.

Manoj Viswanathan