President Biden signed the Inflation Reduction Act of 2022 (“IRA”) into law on August 16, 2022.The deficit reduction bill invests $369 billion in energy security and climate change programs.A significant portion of this investment is reflected through the modification and creation of new energy credits.
While in previous taxable years, not-for-profits were limited to capturing these cash benefits directly unless they had unrelated business income tax (“UBIT”), under the IRA, all not-for-profits are incentivized to invest in clean energy infrastructure through the direct payment program regardless of tax liability. The newly created direct payment option under Internal Revenue Code §6417 generally allows tax-exempt entities and State or political subdivisions to receive a cash tax refund for applicable credits, including credits related to the purchase of qualified commercial vehicles, alternative fuel vehicle refueling property, and energy projects. In addition, the IRA allows tax-exempt entities and State or political subdivisions the opportunity to provide an immediate deduction related to energy-efficient commercial buildings to the person primarily responsible for designing the building, thereby assisting in price negotiation. Some key credits for not-for-profits to evaluate before planning their capital improvements are below.
Qualified Commercial Vehicle Credit
A new federal tax credit is provided upon purchasing qualified commercial vehicles between 2023 and 2032.Qualified commercial vehicles must be propelled to a significant extent by an electric motor that draws electricity from a battery.The maximum credit per vehicle with a gross vehicle weight of less than 14,000 pounds is $7,500 but is increased to $40,000 if the gross vehicle weight is 14,000 pounds or more. The overall credit can be limited based on the incremental costs of the qualified commercial vehicle compared to gasoline or diesel-powered vehicles.
Example:Assume an electric ambulance costs $400,000 per vehicle, and the ambulance weighs more than 14,000 pounds.In addition, a similar ambulance that is gasoline-powered costs $325,000.The maximum federal tax credit allowed for this purchase would be $40,000.The maximum credit can be reduced if the incremental cost of the clean vehicle purchase, $75,000 (400,000-325,000) in our example, was less than the credit.In this example, no additional credit limitation would occur.The purchase of the electric vehicle offset by the federal income tax credit, coupled with lower maintenance and gas costs, may incentivize not-for-profits to increase their investment in clean commercial vehicles.The $40,000 credit in this example would be claimed on their tax return and treated as a federal income tax paid.Alternatively, starting in 2024, some qualified manufacturers may immediately reduce the purchase price on the sale in the amount of the credit provided the customer transfers the credit to the manufacturer.
Alternative Fuel Vehicle Refueling Property Credit
With an increase in clean vehicles, there will also be a higher demand for charging stations. Under the IRA, the federal income tax credit was modified to provide up to 30% of the costs of a qualified alternative fuel vehicle refueling station for property placed in service before December 31, 2032. The modified credit provides a maximum credit of $100,000 per refueling station and is no longer assessed on the entire project.
To qualify as an alternative fuel vehicle refueling station, the property must be new and be for the storage or dispensing of clean-burning fuel, including electricity.In addition, the property must be placed in a low-income community or a non-urban area.
Example:Assume a hospital is interested in adding five additional level three charging stations, and they are deemed qualified alternative fuel vehicle refueling property.The charging station’s purchase price, including installation costs, is $120,000 each. The federal tax credit (refund) could be as high as $180,000 ($120,000 x 30% x 5).The limitation of $100,000 is not applicable as no one charging station exceeded $100,000.
Energy Tax Credits
Many not-for-profits and governmental agencies are finding energy cost too erratic and struggling to properly budget for the significant swings. Some have chosen to explore alternative energy production, including solar energy production, combined heat and power systems, and energy storage technology. Under the IRA, a credit of up to 50% of the costs can be received for energy projects placed in service before January 1, 2025. Ten percent of the credit is provided if the energy project is in an energy community, including Brownfield sites. Another 10% is provided for the utilization of at least 40% of steel, iron, or manufactured products produced in the United States.
The property’s basis generally includes the tangible property’s cost and the capitalizable costs such as sales tax, freight, engineering, and installation. However, certain building structures can sometimes be included if they are an integral part of the energy project.
The credit can be reduced, by not more than 15%, for the utilization of tax-exempt financing for the project.
Example: Assume a not-for-profit entity placed a large commercial solar panel that would generate 250kW’s of electricity in the 2023 taxable year. The cost is estimated to be $750,000.Provided that the total expenses are deemed eligible costs for the energy credit, the not-for-profit could generate a federal tax credit (refund) of $225,000, or 30%, even if it was not located in an energy community or met the domestic steel and iron content requirement.If both the energy community and domestic content requirements are met, the federal tax credit (refund) could be as high as $375,000 (750,000 x 50%).
Energy Efficiency Building Deduction
Some may evaluate energy-efficient building improvements as not-for-profits, and governmental agencies look to reduce expenses.Energy-efficient building improvements could include the installation of interior lighting, HVAC systems, water systems, and adjustments to the building envelope.Suppose it can be certified that the plan designed was able to reduce the building’s total annual energy and power costs by more than 50%. In that case, an immediate tax deduction can be provided for the energy-efficient commercial building property placed in service after December 31, 2022, not to exceed $5 per square foot of the building where the improvement was placed. If the energy-efficient commercial building property could only certify that the plan designed reduced the total annual energy and power costs of the building by 25%, a maximum credit of $2.50 per square foot could be obtained.
While the immediate deduction is not helpful to not-for-profits or governmental agencies that do not pay tax, the IRA allows certain tax-exempt entities to allocate the deductions to the person primarily responsible for designing the property (i.e., architecture firm, engineering firm, etc.).
Example:Assume a not-for-profit expends $750,000 on energy-efficient commercial building property installed in the 2023 taxable year.The square footage of the building is 200,000, and it was certified that the total energy costs were reduced by 40% due to these improvements. Based on the IRA, the maximum dollar amount per square foot would be $4.Therefore, assume the maximum deduction allowed for this space is $800,000 (200,000 square feet x $4 X $800,000).As the energy efficiency improvements were less than $800,000, the full $750,000 of expenditures can be immediately expensed and deducted for tax purposes.
However, as a tax deduction does not benefit a not-for-profit entity (ignoring UBIT), the entity most likely would transfer the deduction to the person primarily responsible for designing the improvements. Assuming the designer has a federal effective tax rate of 20%, the cash benefit the designer will receive for the transferred tax deduction would be$150,000 (20% x 750,000).The not-for-profit would request this be included in their agreement and the benefit included in determining the final purchase price.
How Can Withum Help?
While the overall concepts were provided in our examples, the IRA applicable dates, definitions, and requirements vary based on what property is being placed in service and the type of credit that will be claimed.It can become overwhelming quickly. Withum is here to help not-for-profits throughout the entire process, from the planning stages to the recoupment of refund amounts, to ensure that the most beneficial credits are obtained, and the proper documentation is provided.
Withum will provide a three-phase approach when assisting with the various federal tax incentives.
- Work with the not-for-profit finance function to review significant capital expenditures that could have a clean energy component.
- Help model estimated cost savings, including federal tax credits, increased efficiencies, the transfer of energy-efficient immediate deductions, and the potential use of tax-exempt financing.
- Help present these findings to the appropriate persons for discussion and approval.
- Consult on what investments will meet the clean-energy federal tax requirements, including the potential need for contractors to meet the prevailing wage and apprenticeship requirements, the location of the property in an energy community, and the utilization of content produced in the United States.
- Coordinate with engineers and contractors to ensure the federal tax requirements are being met.
- Utilize the Withum cost segregation team to determine the cost basis that can be utilized for determining the credit, evaluating direct and indirect capitalize costs, and potential exceptions for real property.
- Utilize the Withum cost segregation team to ensure proper certification required for energy-efficient building deduction and transfer.
- Provide proper documentation of the investments and placed in service dates that were utilized to arrive at the federal tax credit or deduction amounts.
- Assist in correctly reporting the tax credits on the appropriate compliance forms and requesting refunds from the federal government.