Direct Pay “Excessive Benefit” Rules & Regulations Fact Sheet

One of the more concerning aspects found in the Department of Treasury’s Guidance and Proposed Regulations for Direct Pay is a little-known provision called “Excessive Benefit”. This provision essentially says that if a nonprofit receives grants/donations that are earmarked for their solar projects, these grants/donations could erode the nonprofit’s ability to claim Direct Pay to the extent that the grants/donations plus the tax credit exceeds the purchase price of the solar project.

As a reminder, Treasury has published both Guidance and Proposed Regulations related to Direct Pay. This information is current as of October 18th, 2023, but keep in mind that we are still awaiting Final Regulations which have not yet been published. Hence, these rules can change… but for the moment, below is the information available directly from Treasury sources.

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…to prevent an excessive benefit, proposed § 1.6417–2(c)(3) would provide that, if an applicable entity receives Tax Exempt Amounts for the specific purpose of purchasing, constructing, reconstructing, erecting, or otherwise acquiring an investment credit property (Restricted Tax Exempt Amount), and the Restricted Tax-Exempt Amount plus the applicable credit otherwise determined with respect to that investment-related credit property exceeds the cost of the investment-related credit property, then the amount of the applicable credit is reduced so that the total amount of applicable credit plus the amount of any Restricted Tax Exempt Amount equals the cost of investment credit property.
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(3) Special rule for investment-related credit property acquired with income, including income from certain grants and forgivable loans, that is exempt from taxation.

For purposes of section 6417, income, including income from certain grants and forgivable loans, that is exempt from taxation under subtitle A and used to purchase, construct, reconstruct, erect, or otherwise acquire an applicable credit property described in sections 30C, 45W, 48, 48C, or 48E (investment-related credit property) are included in basis for purposes of computing the applicable credit amount determined with respect to the applicable credit property, regardless of whether basis is required to be reduced (in whole or in part) by such amounts under general tax principles. However, if an applicable entity receives a grant, forgivable loan, or other income exempt from taxation under subtitle A for the specific purpose of purchasing, constructing, reconstructing, erecting, or otherwise acquiring an investment-related credit property (Restricted Tax Exempt Amount), and the Restricted Tax Exempt Amount plus the applicable credit otherwise determined with respect to that investment-related credit property exceeds the cost of the investment-related credit property, then the amount of the applicable credit is reduced so that the total amount of applicable credit plus the amount of any Restricted Tax Exempt Amount equals the cost of investment-related credit property.
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(5) Examples. The following examples illustrate the rules of this paragraph (c).

(i) Example 1. School district A receives a tax exempt grant in the amount of $400,000 from the Environmental Protection Agency to purchase electric school bus B. A purchases B for $400,000. A’s basis in B is $400,000. B qualifies for the maximum section 45W credit, $40,000. However, because the amount of the restricted tax exempt grant plus the amount of the section 45W credit exceeds the cost of B, A’s section 45W credit is reduced by the amount necessary so that the total amount of the section 45W credit plus the restricted tax exempt amount equals the cost of B. A’s section 45W credit is therefore reduced by $40,000 to zero.

(ii) Example 2. Assume the same facts as in paragraph (c)(5)(i) of this section (Example 1), except that the grant is in the amount of $300,000. A purchases B using the grant and $100,000 of A’s unrestricted funds. A’s basis in B is $400,000 and A’s section 45W credit is $40,000. Since the amount of the restricted tax exempt grant plus the amount of the section 45W credit ($340,000) is less than the cost of B, A’s 45W credit under section 6417(b)(6) is not reduced.

(iii) Example 3. Public charity B receives a $60,000 grant from a private foundation to build energy property, P, a qualified investment credit property that costs $80,000. B uses $20,000 of its own funds plus the $60,000 grant to build P. B’s basis in P is $80,000. Based upon acquisition cost, B can earn a section 48 investment credit (with bonus credit amounts) of $40,000 (50% of basis). However, because the amount of the restricted tax exempt grant ($60,000) plus the section 48 credit ($40,000) exceeds P’s cost by $20,000, B’s section 48 applicable credit is reduced by $20,000 so that the total amount of the section 48 investment credit plus the restricted tax exempt grant equals the cost of P.
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In addition, if you’re looking for an easier to read version, see Question #41 in Treasury’s FAQ

Additional Elective Payment Election Rules

Q41. I funded the purchase of an investment-related credit property with grants and forgivable loans exempt from taxation. Can I include those amounts in the basis of the property for purposes of calculating the amount of the credit? (added June 14, 2023)
A. Yes. For purposes of 6417, any income, including income from certain grants and forgivable loans, that is exempt from taxation (Tax-Exempt Amounts) used to purchase, construct, reconstruct, erect, or otherwise acquire an applicable credit property described in sections 30C, 45W, 48, 48C, or 48E (investment-related credit property) is included in basis for purposes of computing the applicable credit amount determined with respect to the investment-related credit property, regardless of whether basis is required to be reduced (in whole or in part) by such amounts under other provisions of the Code.

However, if you receive Tax-Exempt Amounts for the specific purpose of purchasing, constructing, reconstructing, erecting, or otherwise acquiring an investment credit property (Restricted Tax-Exempt Amount), and the Restricted Tax-Exempt Amount plus the applicable credit otherwise determined with respect to that investment-related credit property exceeds the cost of the investment-related credit property, then the amount of the applicable credit is reduced so that the total amount of applicable credit plus the amount of any Restricted Tax-Exempt Amount equals the cost of investment credit property.

For example, School district A receives a tax-exempt grant in the amount of $400,000 from a federal agency to purchase electric school bus B. A purchases B for $400,000. A’s basis in B is $400,000. B qualifies for the maximum section 45W credit, $40,000. However, because the amount of the restricted tax-exempt grant plus the amount of the section 45W credit exceeds the cost of B, A’s section 45W credit is reduced by the amount necessary so that the total amount of the section 45W credit plus the restricted tax-exempt amount equals the cost of B. A’s section 45W credit is therefore reduced by $40,000 to zero.

Now assume that the grant above is in the amount of $300,000. A purchases B using the grant and $100,000 of A’s unrestricted funds. A’s basis in B is $400,000 and A’s section 45W credit is $40,000. Since the amount of the restricted tax-exempt grant plus the amount of the section 45W credit ($340,000) is less than the cost of B, A’s 45W credit under section 6417(b)(6) is not reduced.

In a third example, public charity B receives a $60,000 grant from a private foundation to build energy property, P, a qualified investment credit property that costs $80,000. B uses $20,000 of its own funds plus the $60,000 grant to build P. B’s basis in P is $80,000. Based upon acquisition cost, B can earn a section 48 investment credit (with bonus credit amounts) of $40,000 (50% of basis). However, because the amount of the restricted tax-exempt grant ($60,000) plus the section 48 credit ($40,000) exceeds P’s cost by $20,000, B’s section 48 applicable credit is reduced by $20,000 so that the total amount of the section 48 investment credit plus the restricted tax-exempt amount equals the cost of P.

Disclaimer: This information does not constitute legal or tax advice and should not be relied upon for any purpose. Please consult your legal counsel and tax advisor.