On August 16, 2022, the Inflation Reduction Act (IRA) was signed into law (P.L. 117-169). The IRA contains several provisions affecting tax-exempt entities, including the opportunity to participate in federal investment tax credits under the new IRC Section 6417 that encourages investment in clean energy and expands incentives for energy-efficient construction by tax-exempt entities; a 15% corporate alternative minimum tax based on adjusted financial statement income for corporations with profits exceeding $1 billion ($1 billion of unrelated business taxable income for tax-exempt corporations); and increased IRS funding to enhance enforcement and customer service.
The federal investment tax credit (ITC), also known as the solar tax credit, is one of the most lucrative incentives for installing solar energy for homes and businesses. Prior to the passing of the IRA, tax-exempt entities could not take advantage of the ITC since tax-exempt entities do not have a tax liability. The IRA will allow tax-exempt entities, including affordable housing developers, community-based organizations, and state, local, and tribunal governments, to have the option for the ITC as an upfront direct payment, rather than a credit.
The IRA provides for an election for direct payment in lieu of a tax credit. The irrevocable direct pay election is required to be made no later than the due date for the return for the taxable year for which the applicable credit is determined. Any direct payment election must be made on a per facility/project/equipment basis. Direct pay allows project owners to apply for tax refunds in an amount equal to the value of their credits.
The IRA will allow these entities seeking to develop solar PV and battery storage solutions in low-income communities by removing barriers to accessing significant federal tax incentives. In addition, tax-exempt hospitals, universities, and other tax-exempt entities that invest in energy-efficient buildings can take advantage of these incentives, as they may now be eligible for financial benefits under the expanded tax deduction. Tax-exempt entities will no longer need to partner with third-party entities to reap the full rewards of this credit.
15% Corporate Alternative Minimum Tax
Tax-exempt entities will also be liable for the new 15% corporate alternative minimum tax applicable to entities with unrelated business taxable income (including debt-financed income) exceeding $1 billion. Affiliated tax-exempt entities will need to evaluate whether they are part of a controlled group of corporations when determining the $1 billion dollar threshold.
The 15% corporate alternative minimum tax takes effect for tax years beginning after December 31, 2022. Tax-exempt entities will be subjected to the newly enacted IRC §56A(c)(12). The new section requires adjusted financial statement income (AFSI) to take into account solely AFSI attributable to (a) an unrelated trade or business; and (b) debt-financed property, to the extent the income is treated as unrelated business taxable income.
Tax-exempt entities should review IRC §52(a) and §52(b) to determine which of their affiliates must be treated as part of a controlled group of corporations. Unrelated business taxable income from those affiliates must then be aggregated when determining if the group meets the $1 billion threshold.
Enhanced IRS Funding
The IRA provides for $80 billion in increased funding to help the IRS improve taxpayer services and compliance. More than half of the new spending is dedicated to enforcement with the remainder focused on business systems modernization, e-file systems (which should enable the IRS TEGE division to process e-filed Forms 990, 990-PF, 990-T, and 4720 more efficiently and effectively), enforcement, and customer service. Tax-exempt entities may likely see an increase in IRS examinations and other enforcement activity. With this potential increase in audits, tax-exempt organizations continue to have an obligation to maintain proper tax compliance, reporting, and supporting documentation.
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