US climate law introduces billion-dollar ​‘game-changer’ for nonprofits

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Michelle Moore, CEO of the Washington, D.C.–based nonprofit Groundswell, sees a world of new opportunities opening up for the churches, colleges and community centers her organization helps to access clean energy.

The key to unlocking that opportunity? Two words: ​“Direct pay.”

Tax credits have been the primary engine of federal clean energy policy for the past two decades, and the Inflation Reduction Act continues that legacy. But up until now, these powerful incentives have been available only to for-profit companies seeking to offset their tax burdens.

“From a policy perspective, tax credits reward wealth with ownership, and everyone else gets left behind,” Moore said. 

But nestled within the Inflation Reduction Act is a provision that has unleashed hundreds of billions of dollars of clean-energy tax credits to city and county governments, schools and universities, nonprofits, tribal communities and other entities that don’t pay federal taxes. The provision is known as direct pay, and it’s ​“a game-changer,” according to Moore.

In the past, nonprofits had to try to partner with for-profit groups to access clean-energy tax credits — a process that’s time-consuming and labor-intensive, and which erodes the value of incentives as different middlemen take their cut. Now, they can access benefits directly.

This under-the-radar provision could fuel untapped decarbonization opportunities in key areas like cities, public utilities and rural electric cooperatives. But perhaps more importantly, it will help advance equity and energy self-determination for underserved groups.

More municipalities may decide to build their own clean power projects, more tribes can draw investment into sovereign solar and wind projects, and more nonprofits can work with community centers and houses of worship on solar- and battery-backed microgrids.

In June, Moore joined senior Biden administration officials in unveiling official guidance from the Treasury Department that allows tax-exempt entities to apply for and receive the value of the Inflation Reduction Act’s tax credits, which range from 30 percent to as much as 60 percent of the value of clean energy, low-carbon fuel and other eligible projects, in the form of checks from the IRS.

Just months after that guidance was finalized and one year after the act was signed into law, examples of its impact are already springing up. One example is the first direct-pay project Groundswell is developing — a rooftop solar and backup battery installation at the main campus of faith-based nonprofit City of Refuge in Baltimore.

The project will involve the same solar and battery contractors and financial partners as a previous third-party-owned solar-battery project Groundswell developed with the nonprofit at its youth center in Baltimore, but this time, it will be owned directly by City of Refuge, Moore said.

“What that opens up is not only more equitable access and the ability to more fully realize the economic benefit,” she said. ​“It also opens up the opportunity for community ownership,” which can increase property values and improve the ability of community organizations to borrow at lower interest rates and attract capital investments for further improvements.

How direct pay makes clean energy more affordable for nonprofits

The main thing to know about direct pay is that it makes the process of nonprofits accessing cheap, carbon-free energy much simpler and much more certain.

“Before direct pay, for nonprofits like churches to realize the value of tax credits, you had to bring a tax-equity investor into the picture,” Moore said.

That space has been dominated by a relatively small number of large banks and other financial institutions that prefer ​“large, repeatable projects,” such as utility-scale wind and solar projects or clean energy and efficiency investments across large corporate property portfolios.

Community power projects don’t fit that model. Because they’re much smaller than the $100-million-and-up projects traditionally targeted by tax equity investors, they have in the past required the intervention of intermediaries willing to aggregate them into larger portfolios.

Direct pay, officially known as ​“elective pay,” ​“flips that on its head,” Moore said.

Efforts to take advantage of this new and streamlined process are underway in cities and municipal utilities around the country. Some entities are even reworking in-progress projects on the fly, adjusting them to seize the new opportunity for direct ownership.

Take Peninsula Clean Energy, one of California’s many community choice aggregators formed for the purpose of offering clean energy at lower prices than those of the state’s investor-owned utilities. In April, PCE unveiled one of the country’s earliest large-scale implementations of the new direct-pay provision: 1.7 megawatts of solar projects it’s developing on the rooftops of public buildings across its territory of San Mateo County and the city of Los Banos in California’s Central Valley.

“Direct pay wasn’t on the table” when work on this project started several years ago, said Rafael Reyes, PCE’s director of energy programs. PCE had planned to take a standard approach: partnering with a third-party solar developer capable of bundling its project into a portfolio that could attract tax-equity financing.

But those deals involve a lot of costly legal and administrative work, he said. The aggregators and investors also need to earn money, cutting into the value of the tax credits that could be passed back to the public agencies hosting the solar systems.

Reyes estimated that the third-party structure PCE initially envisioned would have reduced the value of the incentive for the participating agencies by more than a third. ​“That’s a pretty big bite,” he added.

With direct pay, by contrast, ​“not only do we get the direct benefits, but we dramatically reduce the legal expenses,” he said. That allows PCE to lower the cost of the solar systems it’s helping its county and city partners build.

This summer’s Treasury Department guidance also clarified that community choice aggregators like PCE are eligible for direct pay, allowing them to retain their role as project developer, he said. Now it can help cities and counties assess the best sites for solar, vet different contractor proposals and bundle multiple projects to get better deals.

PCE is planning a second round of public-building projects for construction next year aimed at delivering between 5 and 10 megawatts of rooftop solar, and it plans to share its experience with other CCAs, Reyes said. ​“That’s our intent — to democratize this approach.”

Publicly owned utilities could also harness direct pay to expand their clean energy ambitions, according to Eric Dresselhuys, CEO of flow battery company ESS. His company was working on the largest-ever U.S. flow battery deployment with California’s Sacramento Municipal Utility District before the Inflation Reduction Act was passed, and it has since followed up with deals with other public utilities including Turlock Irrigation District and Burbank Water & Power.

“We think there’s a lot of pent-up demand,” he said. ​“I don’t know if I can put a number to it. But I do believe this has tipped the economics for a lot of the non-taxpaying entities.” 

Katrina McLaughlin, an associate on the U.S. energy program of nonprofit World Resources Institute, noted that clean power projects aren’t the only investments that can receive direct pay. Tax credits for commercial electric vehicles and EV charging equipment are also eligible, and ​“local governments have fleets, and have electrification plans for those fleets,” she said.

Building the support structures to put direct pay to work

That’s not to say that tapping into direct pay is a trivial task. Just ask Janean Weber, assistant director of sustainability at the city of Columbus, Ohio’s Department of Public Utilities.

Columbus wants to cut citywide emissions by 45 percent by 2030, and to help hit that goal, it’s planning to build solar, backup batteries and biomethane to power projects at its wastewater treatment plant, Weber said during a July webinar hosted by WRI.

Being able to use direct pay ​“substantially reduces the capital that we need to generate for our projects, and we also move up the timeline substantially,” she said. 

It took a lot of work for Columbus and its developer partners to make sure that switching the projects from third-party ownership to city ownership would pencil out financially, however. The city’s municipal utility had already signed a power-purchase agreement with developer NextEra when the Inflation Reduction Act was passed, and ​“we were sort of scrambling on the back end” to figure out whether switching to a city-owned project ​“would be worth it,” Weber recounted.

One key question was what type of tax credits the project could qualify for. The Inflation Reduction Act offers ​“adders” to the base 30 percent tax credit for clean energy projects, including an additional 10 percent for projects located in ​“energy communities” — census tracts where coal, oil or fossil gas infrastructure has caused environmental harms, or where closing coal mines or power plants has led to lost jobs and declining tax revenue.

Back when Columbus started looking at direct pay, the criteria defining energy communities hadn’t yet been released. That made it hard to know if its wastewater treatment plant qualified for the additional credit, she said. Since then, the federal government has issued clear guidance on which census tracts are eligible for the additional tax credit.

Columbus also ​“wanted to make sure that prospective bidders on this contract would understand how we were planning to bridge the gap” in financing, Weber said. While tax credits will cover 40 percent of the project’s cost, direct-pay recipients must wait a year after the project begins operation to receive their funds. That means they have to work with financing partners to secure equity and debt capital financing to cover those upfront costs, as well as the remaining project costs.

“You need construction and bridge financing to get the value of the tax credit,” said Moore. ​“That will be a little bit of a new trick for solar developers,” as well as the banks and project financing partners they work with, many of which aren’t used to working directly with community groups and nonprofits. Groundswell recently launched a Community Power Fund initiative that aims to help sort through issues like this.

Marginalized or under-resourced communities might also require additional investment, Moore said — ​“things like new electrical infrastructure or new rooftops” — to prepare buildings for solar, energy-efficiency or electrification projects. That’s going to require ​“more community-based developers whose vision is broader than just the return on investment of solar as an asset class.”

The Inflation Reduction Act’s 10 percent tax-credit adder for projects located in designated lower-income communities could help draw investment to cover these costs, particularly ​“in neighborhoods that have been subject to redlining [and] areas where you need to make all kinds of reparative investments,” Moore said.

Building clean energy ownership in underserved communities

One way that the Treasury Department’s guidance will help counterbalance the challenge of investing in underserved communities is by allowing direct-pay tax credits to ​“stack” with other federal grants and loans, Moore said. That’s a shift from many previous federal programs that limited how many different sources of federal funding could be used to pay for a single project.

That means that other major pots of money, like the $27 billion in loans being made available from the Environmental Protection Agency’s Greenhouse Gas Reduction Fund — the official name of the federal ​“green bank” created by the Inflation Reduction Act — can be combined to further improve the financial equation for community power projects, she said.

Keith Dennis, president of the nonprofit Beneficial Electrification League, described a similar ​“stackable” option now available for the more than 900 rural electric cooperatives that provide power to about 42 million people across the country. These cooperatively owned entities are eligible for direct pay, and they’re also allowed to compete for $10.7 billion in U.S. Department of Agriculture grants and loans under two Inflation Reduction Act programs that opened up for applications this spring.

By combining those grants and loans with the most lucrative direct-pay tax credits available for energy communities and low-income communities, co-ops can ​“get close to 100 percent” of a project’s cost covered by the federal government, said Dennis, who spent nine years as an executive with the National Rural Electric Cooperative Association.

Dennis said his organization is now working with co-ops seeking low-interest loans from a $1 billion pool of these new USDA funds to build and own clean energy projects. ​“Those people will probably be looking at using direct pay to supplement that funding,” he said. ​“The only way you wouldn’t use it is if you miss the deadline accidentally.”

But co-ops have other options. The majority of the USDA funding — $9.7 billion of it — offers co-ops loans or grants they can use to sign power-purchase agreements with third-party developers as well as build their own projects. ​“It’s going to take some practice in seeing how this works” for co-ops to understand which is a better deal, he said.

Chéri A. Smith, founder and CEO of Alliance for Tribal Clean Energy and a descendant of the Mi’kmaq Nation of present-day Maine and the Canadian Maritime provinces, cited similar uncertainty among the tribal nations and Indigenous communities she works with to finance and build clean energy projects on tribal lands.

“There’s an enormous amount of capacity-building that needs to be done, with our federal partners and others, to get this funding to work,” she said. Alliance for Tribal Clean Energy is working on what she described as a ​“capital-stack planning tool,” a cloud-based repository of data on tax credits, grants, loans and financing options for ​“tribal leaders to go in, with support from our technical team, to slice and dice the different options” and to ​“show how direct pay will come in at the end.”

Tribal communities have a particular interest in controlling the clean-energy assets being built on their land, given the history of private-sector exploitation of their fossil-fuel and mineral wealth, Smith said.

Similar concerns animate much of the interest in clean energy development among the nonprofits and faith-based organizations that Groundswell works with, Moore said. She cited the example of the Interdenominational Theological Center in Atlanta, a group of five historically Black seminaries that considers building the assets of Black churches for wealth creation as one of its missions.

“Asset ownership of solar — bringing the ownership of that asset into your community and literally owning your own power — is very vital to that mission,” she said.

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