Transferability and Direct Pay: Getting the Most out of Energy Tax Credits

In 2022, Congress made important changes to how utilities and developers of clean energy and advanced manufacturing projects can monetize the value of tax credits their projects are eligible for. As Congress discusses extending the Tax Cuts and Jobs Act, there is growing interest in reexamining energy tax credit provisions, including both direct pay and transferability.

Energy tax credits support energy projects by lowering the developer’s tax burden. However, tax credits don’t provide any direct benefit to entities without a tax liability, such as startups, local governments, and electric cooperatives. Prior to the Inflation Reduction Act becoming law in 2022, the only way for such entities to monetize energy tax credits was through tax equity transactions. This form of project financing allows developers to “sell” tax credits to an investor with a large tax liability in exchange for cash and an ownership stake in the project. This process, however, has proven costly and cumbersome, requiring complicated ownership structures.

Direct pay (also known as elective pay) and transferability were designed as two solutions to this problem. These provisions enable efficient deployment of energy tax credits, provide support for innovative technologies, and extend the benefits of the tax credits to local governments, rural electric co-ops, non-profits and other entities that previously were unable to benefit from the credits. This blog post will explain how transferability and direct pay work and why they are beneficial for American energy.

Transferability 

What is it?

Transferability is a mechanism that allows entities to transfer all or a portion of a tax credit to a third-party buyer in exchange for cash.

Why is it good for American energy? 

More money goes into innovative energy technologies instead of transaction fees.  

Past tax equity markets were shallow—only a few large entities had a tax liability large enough to make such complicated transactions worthwhile. Today, transferability permits the sale of tax credits to a party that does not need to take an ownership stake in the project, meaning a larger market exists for these credits. This has led to a higher value for credits than within tax equity markets due to simpler transactions and a larger pool of investors. Tax equity transactions require costly fees for due diligence and accounting, resulting in some projects losing at least 15% of the value of the tax credits

In contrast, transferability allows developers to sell credits for cash while retaining ownership over the project. Tax transfer pricing averages 92.5 cents for investment tax credit (ITC) deals and 95 cents for productions tax credit (PTC) deals, resulting in only 5-7.5% of the value of credits, on average, going to transaction costs. Transferability allows for a greater share of the tax credit to go directly to the project developer. This lowers the costs of energy production while simultaneously reducing energy costs for consumers.

Advanced technologies are benefiting the most.

According to Crux, a capital markets platform focused on sustainable energy, emerging technologies including advanced manufacturing; nuclear; bioenergy; geothermal; and carbon capture, utilization, and storage (CCUS) comprised 67% of transferability transactions in the second half of 2024. Nascent energy technologies are benefitting greatly from transferability, and the market is growing, reaching almost $30 billion in 2024.

Energy developers get cash in hand more quickly.  

By monetizing tax credits with transferability, project developers don’t have to take on more debt or sell ownership of the project to get the cash value of the energy credits. This allows companies to have greater liquidity, which in turn allows them to continue to grow their investments in energy projects.

Direct Pay

What is it? 

Direct pay allows certain eligible entities to receive the full value of a tax credit as a direct payment from the U.S. Treasury Department upon filing a tax return for certain energy tax credits (such as the technology neutral ITC and PTC).

Rural electric co-ops, tax-exempt organizations, and state and local governments, including public power utilities, are some of the key entities that can use direct pay. For-profit entities are only able to use direct pay when they build projects that quality for the 45Q (CCUS), 45V (hydrogen), or 45X (advanced manufacturing) tax credits.

Why is it good for American Energy?

Direct pay is efficient.

As with transferability, direct pay circumvents the tax equity markets and allows project developers, including electric cooperatives and public power utilities, to receive the full value of the tax credit. Historically, co-ops and public power utilities unable to monetize the clean energy tax credits would rely on power-purchase agreements with project developers. Those developers would be able to engage in a tax equity transaction but often could not pass the full savings onto the utility or a cooperative’s customer-owners.

Direct pay is more impactful.  

Direct cash transfers, in general, stimulate more investment in infrastructure. Studies have shown that direct cash subsidies, which are functionally equivalent to “direct pay,” incentivize up to two times the actual deployment of energy infrastructure per dollar spent.

Direct pay promotes more innovation.

This is important for new businesses developing nascent technology; without direct pay, they may not have enough taxable income or tax liability to be eligible for the full value of these credits. As BPC has previously described, direct pay is crucial for burgeoning technologies such as CCUS and advanced nuclear.

Direct pay allows entities without tax liability—such as rural co-ops, public power, and school districts—to take advantage of energy tax credits.

Examples of projects that have utilized direct pay since provision’s inception in 2022 include:

• Hart County Schools in Kentucky received nearly $800,000 for a geothermal system in one of its elementary schools using direct pay. This was one of the first school districts in the nation to utilize direct pay. School districts are one of the entities that are able to receive cash refunds for clean energy tax credits.
• The Northeastern Rural Electric Membership Corp, a co-op in Columbia City, Indiana, used direct pay to develop a utility-scale solar and battery storage project. Without direct pay, co-ops would be unable to access tax credits, making the direct pay provisions vital to these entities and lowering power costs for Columbia City customers.
• The City of Aztec, NM, is constructing a 2 megawatt solar farm with battery storage to stabilize energy costs and improve the community’s resilience. Direct pay is permitting this public power utility to maintain ownership of this project and pass the savings from the energy tax credits on to community members.

Next Steps

Direct pay and transferability are allowing for more efficient deployment of the federal tax benefits for clean energy development. Direct pay enables rural co-ops, municipal utilities, and state and local governments without a tax liability to benefit from these incentives. Transferability allows for lower transaction costs and a larger pool of financing options for advanced manufacturing and developers of nascent technologies such as CCUS. These mechanisms offer a tangible boost to the development of American energy and decrease energy costs.