Direct Pay Under §6417: A Hundred Cents on the Dollar, With a Condition That Reaches Zero
A transfer sells a credit at roughly ninety-three cents. Direct pay converts it into a refund at a hundred. For an entity that qualifies, there is no buyer to find, no discount to negotiate, no recapture indemnity and no insurance premium — the credit is simply treated as a payment of tax and refunded.
The condition attached to that is severe and gets worse on a schedule. For a project beginning construction on or after 1 January 2026, failing the domestic content requirement reduces the elective payment to zero percent — not a haircut, the entire amount. And the entities that qualify for direct pay are, as a class, the least equipped to control a supply chain.
This is the fifth post in the tax structuring series. You will get who qualifies, the narrow route available to everyone else, the phaseout schedule and its two exceptions, why partnerships are largely shut out, and where the chaining question sits.
ℹ️ Note: This describes how these rules work in practice. It is not tax advice — elective payment eligibility and the domestic content exceptions are fact-specific.
What Does Direct Pay Actually Do?
Converts a credit into cash from the government. An applicable entity making an elective payment election is treated as having made a payment against its federal income tax equal to the credit — so if it has no liability, it receives a refund.
That is a fundamentally different mechanism from everything else in this series. A partnership flip finds someone with tax capacity and shares the project with them. A transfer finds someone with tax capacity and sells to them at a discount. Direct pay does not need anyone with tax capacity at all.
The absence of a counterparty removes an entire category of cost and risk: no price discount, no buyer diligence, no seller indemnity, no recapture allocation to negotiate, no insurance. For an entity that qualifies, it is the cheapest monetisation route available by a wide margin.
Who Qualifies?
A defined list, and membership is the whole question. Holland & Knight records the regulatory definition of applicable entities as including "tax-exempt entities, state or local governments (or political subdivisions thereof), the Tennessee Valley Authority, tribal governments and any Alaska Native corporation." Cooperatives furnishing electric energy — rural electric co-ops — are also within the definition.
Applicable entities can elect for twelve applicable credits, covering the main clean energy production and investment credits plus commercial clean vehicles, alternative fuel refuelling property and carbon oxide sequestration.
This is the population the inverted lease post identified as excluded from the pass-through election: government agencies, tax-exempt entities and tribes. Direct pay exists precisely because those entities had no route to monetise a credit and no tax liability against which to use one.
Can Anyone Else Use It?
Yes, narrowly. Taxpayers who are not applicable entities — described in the regulations as electing taxpayers — can elect direct pay for exactly three credits: 45V clean hydrogen, 45Q carbon oxide sequestration, and 45X advanced manufacturing.
Three features constrain it further.
It runs for five years. The election is effective for a five-year period.
Revocation is one-way. The election can be revoked, but a revocation cannot itself be reversed. That makes it a genuine commitment rather than an annual choice.
Partnerships are limited to the same three. Partnerships and S corporations can elect direct payment only for 45V, 45Q and 45X, on the same footing as any other non-applicable entity.
That last point matters for structuring. A project owned through a partnership — which is most utility-scale renewable generation — cannot use direct pay for its investment or production credit, whatever the tax status of its partners. The entity that makes the election has to be the applicable entity itself.
Why Isn't This Just Transferability for Non-Profits?
Because the economics, the conditions and the counterparty risk are all different.
| Transfer (§6418) | Direct pay (§6417) | |
|---|---|---|
| Proceeds | ~92.5–95 cents | 100 cents |
| Counterparty | A buyer must be found | None — the government |
| Recapture | Borne by the buyer | Stays with the entity |
| Insurance | 3–5 cents typical | Not applicable |
| Domestic content | Not a condition | A condition, phasing to zero |
| Who can use it | Any taxpayer | Applicable entities; three credits for others |
The headline comparison favours direct pay by seven cents or so. The condition attached is what makes the comparison less simple, and it is the subject of the next section.
The Phaseout That Reaches Zero
The elective payment is reduced if the project does not meet the domestic content requirement, and the reduction schedule is set by the year construction begins:
| Construction begins | Applicable percentage if domestic content not met |
|---|---|
| 2023 or earlier, or under 1 MW | 100% |
| On or after 1 January 2024 | 90% |
| On or after 1 January 2025 | 85% |
| On or after 1 January 2026 | 0% |
That final row is not a typo. As the phaseout is described, for a project beginning construction in 2026 or later that does not meet domestic content, "the credit value is reduced to zero percent of its potential value."
Compare that with the position for an ordinary taxpayer. As the domestic content post in the policy series covered, a developer that misses domestic content loses a ten percentage point adder and keeps the rest of its credit. An applicable entity that misses it, on a 2026 start, loses everything.
The asymmetry is uncomfortable because of who it falls on. A municipal utility, a rural cooperative or a school district has less procurement leverage than a large developer, less ability to pay a domestic premium, and less capacity to run a component-by-component domestic content analysis — and it faces a far harsher consequence for failing.
The under-one-megawatt carve-out is therefore doing substantial work for smaller entities, in the same way the one megawatt exception does for prevailing wage.
What Are the Two Exceptions?
Two statutory escapes, either of which restores the applicable percentage to 100%.
The increased cost exception applies where including steel, iron or manufactured products produced in the United States "increases the project's overall costs of construction by more than 25%."
The non-availability exception applies where "the relevant steel, iron, or manufactured products are not produced in the U.S. in sufficient and reasonably available quantities."
Both are genuinely usable, and both are evidentiary. The relief comes with an attestation requirement: applicable entities attach attestations to Form 8835 or Form 3468, "signed by an individual with the power to bind the applicable entity" and "made under the penalties of perjury."
That combination — a meaningful exception, available on attestation, made under penalties of perjury — sets the standard for the file behind it. An entity relying on the increased cost exception should be able to show the domestic and non-domestic quotes it compared and the calculation producing the 25% figure. One relying on non-availability should be able to show which suppliers were approached and what they said.
There is transitional relief for early movers: where an applicable entity provides the attestation and follows the recordkeeping requirements for property whose construction begins before the later of 1 January 2027 or the issuance of further guidance, the attestation is treated as establishing that the exception is met.
How Do Partnerships Work Around the Limitation?
By not being partnerships. The regulations address "elections by certain unincorporated organizations that are owned by one or more applicable entities to be excluded from the application of the partnership tax rules."
That is a meaningful structural route. Where two or more applicable entities co-own a project — two municipal utilities, or a co-op and a tribal entity — the arrangement would ordinarily be treated as a partnership, and partnerships cannot elect direct pay for investment or production credits. Electing out of partnership treatment allows each owner to be treated as owning its share directly, and each can then make its own elective payment election.
The practical consequence is that joint ownership among applicable entities is workable, but it has to be structured deliberately and the election made properly. A co-ownership arrangement that drifts into partnership treatment loses direct pay entirely for all participants.
What Is the Chaining Question?
Whether a taxpayer that bought credits under section 6418 can then claim direct payment on them. The answer, for now, is no.
Holland & Knight records the position: "prior proposed regulations disallowed a taxpayer who had purchased credits from a transferor under Section 6418 to claim direct payment of such purchased credits," with the IRS issuing Notice 2024-27 requesting comments on whether to permit the practice.
The reason it matters is structural. If chaining were permitted, an applicable entity could buy credits from a developer and convert them to cash at full value — creating a route for tax-exempt capital to fund projects it does not own. That would be a materially different market, and its absence is why direct pay remains tied to ownership rather than becoming a purchasing power.
When Does the Cash Actually Arrive?
Later than people assume, and the lag is a financing problem rather than a rounding error.
The election is made on an original return filed by the due date including extensions — not on an amended return. An applicable entity that does not ordinarily file an income tax return still has to file one to claim the payment, and the payment is processed as a refund of that return.
The practical sequence for a project placed in service in year one therefore runs: place in service during the year, close the books, file the return in the following year, and receive the refund some months after filing. An entity should model the cash as landing well into year two, not at commercial operation.
Two consequences follow.
It is a receivable, not a source at COD. In a sources and uses at commercial operation, direct pay proceeds are not available. Something has to fund the gap — sponsor equity, a revolving facility, or a bridge loan secured on the anticipated payment.
Bridge lending against it is a real market. The lender's credit question is the same one the entity faces: will the payment arrive, and at what percentage? On a 2026 start where domestic content is in doubt, the honest answer is that the payment is either a hundred percent or nothing — which is a far harder bridge to underwrite than a transfer where the discount is known and the buyer is contracted.
Pre-filing registration is a prerequisite, as it is for transfers. Each credit property receives a registration number that has to appear on the return; a missing or invalid number is a straightforward way to lose the payment on procedure rather than substance.
ℹ️ Note: Model direct pay proceeds on a filing-and-refund timeline, not at placed-in-service. An entity that shows the cash arriving at COD is understating its peak funding requirement by the full credit amount.
Who Bears Recapture?
The entity itself, with nobody to pass it to.
This is the unavoidable counterpart to having no counterparty. In a transfer, the recapture liability sits with the buyer, and the seller negotiates an indemnity that determines how much of it comes back — the previous post spent considerable time on that negotiation because it is where much of the transfer discount is actually priced.
In direct pay there is no negotiation because there is no second party. If a recapture event occurs within the five-year period — the property is disposed of, ceases to qualify, or is otherwise taken out of service — the consequence lands on the applicable entity that received the payment.
For an entity with no tax liability, that produces an odd result: it owes tax it would not otherwise have owed, arising purely from having taken the payment. The obligation is real, and it is why the operational covenants around a directly-paid asset deserve the same attention a tax equity partnership would give them.
The practical controls are the same as anywhere else: do not sell the asset within five years, do not let it cease to be qualifying property, and treat any change of ownership at the project company level as a recapture question before it is a commercial one. The difference is only that here there is no buyer's tax department checking the same list.
What Happens If the Claim Is Too Large?
It costs more than simply losing the excess. Where an elective payment exceeds the credit properly allowable, the excessive payment is recovered with an additional amount equal to twenty percent of it, unless the entity can show reasonable cause.
That changes the calculus on aggressive basis. A developer that overstates eligible basis on an ordinary credit claim faces disallowance of the excess. An applicable entity that overstates it on an elective payment faces disallowance plus a fifth on top.
The reasonable cause exception is meaningful and is exactly where documentation earns its keep — a cost segregation study, a third-party basis appraisal, contemporaneous invoices tied to the claimed basis. An entity that claimed a number because its EPC contractor supplied it, with nothing behind that, is poorly placed to argue reasonable cause.
The combined effect of the twenty percent addition and the perjury-level attestation on domestic content is that direct pay is procedurally less forgiving than an ordinary credit claim, not more. The money is cleaner; the compliance is not lighter.
How Do You Model Direct Pay in Excel?
As full-value proceeds subject to a binary domestic content condition whose consequence depends on a date.
The inputs
Assumptions, labelled as such:
Eligible basis $250,000,000
ITC rate (with PWA) 30%
Gross credit $75,000,000
Project size above 1 MW AC
Domestic content met? to be determined
The value if domestic content is met
Direct_Pay_Received = 75,000,000 × 100% = $75,000,000
No discount, no insurance, no transaction costs beyond compliance. Compare against a transfer at 93.5 cents netting to roughly 88.5 cents after insurance and costs — a difference of about $8.6m on the same credit.
The value if it is not met
BOC in 2024 → 75,000,000 × 90% = $67,500,000
BOC in 2025 → 75,000,000 × 85% = $63,750,000
BOC in 2026 → 75,000,000 × 0% = $0
The cliff
Cost of slipping BOC from 2025 to 2026, domestic content unmet
= $63,750,000
That is the number to put in front of a board. Not a percentage, not an adder — the entire credit, turning on whether construction began before a New Year's Eve.
The timing line
Placed in service Year 1, month 9
Return filed (with extension) Year 2, month 9
Refund received (assumption, label it) Year 2, month 12
Bridge requirement = $75,000,000 × ~15 months of carry
At a 7% bridge rate, fifteen months of carry on $75m is roughly $6.6m — which takes the seven-cent advantage over a transfer and gives a meaningful part of it back. Direct pay is still the better route, but the gap is narrower than the headline comparison suggests, and a model that ignores the carry overstates it.
The decision the model should force
Cost_Of_Domestic_Compliance = incremental procurement premium
Value_Protected = $75,000,000
Exception_Available? = cost premium > 25% OR non-availability
If premium > 25% of construction cost → exception applies → 100% regardless
Note the shape of that last line. The increased cost exception is not a penalty for an expensive supply chain — it is relief triggered by an expensive supply chain. An entity facing a domestic premium above 25% is better protected than one facing a premium of 20%, which is the one genuinely counterintuitive result in the regime and worth testing explicitly.
ℹ️ Note: Model the applicable percentage as a lookup on beginning-of-construction year, not as a constant. A model built in 2024 with "90%" hardcoded will silently overstate a 2026 project by the full credit.
To run the full version — the applicable percentage keyed to your BOC year, the two exceptions tested against your own procurement data, and direct pay compared against a transfer net of all friction — prompt Dezzmond with your project and entity details.
What Do Entities and Their Advisers Actually Check?
- Is the entity an applicable entity? The list is specific and membership is binary.
- What is the beginning-of-construction year? It sets the applicable percentage, and 2026 is a cliff.
- Is domestic content met, or does an exception apply? With the evidence behind the attestation.
- Is the project under 1 MW AC? That preserves 100% regardless.
- If co-owned, has the election out of partnership treatment been made? Partnerships cannot elect for ITC or PTC.
- Has pre-filing registration been completed? Required, as for transfers.
- Was the election made on a timely original return? Including extensions, and not on an amended return.
Frequently Asked Questions
Who can use direct pay?
Applicable entities: tax-exempt entities, state and local governments and their political subdivisions, the Tennessee Valley Authority, tribal governments, Alaska Native corporations and electric cooperatives. Other taxpayers can elect only for the 45V, 45Q and 45X credits, for a five-year period.
How much does an entity receive?
The full credit amount, treated as a payment of tax and refunded where there is no liability — a hundred cents on the dollar, against roughly 92.5 to 95 cents in the transfer market before insurance and transaction costs.
What happens if domestic content is not met?
The elective payment is reduced: to 90% for construction beginning in 2024, 85% for 2025, and 0% for construction beginning on or after 1 January 2026. Projects under one megawatt, and those beginning construction in 2023 or earlier, keep 100%.
Are there exceptions to the domestic content requirement?
Two. If domestic sourcing would increase overall construction costs by more than 25%, or if the relevant steel, iron or manufactured products are not available in sufficient and reasonably available quantities, the applicable percentage returns to 100%. Both require an attestation under penalties of perjury.
When does the money arrive?
After the return claiming it is filed and the refund processed — typically well into the year following the year the property is placed in service. It is not a source of funds at commercial operation, and the gap is usually bridged.
What happens if the claim is too high?
The excessive payment is recovered together with an additional twenty percent of it, unless the entity establishes reasonable cause. That makes documented basis substantially more valuable here than on an ordinary credit claim.
Can a partnership elect direct pay?
Only for 45V, 45Q and 45X. For investment and production credits the election must be made by the applicable entity itself, which is why co-owning entities elect out of partnership treatment.
Closing: The Cheapest Route, and the Narrowest
Direct pay is the best deal in this series for anyone who can use it. Full value, no counterparty, no discount, no indemnity chain, no insurance. Every friction the previous post spent three thousand words describing simply does not arise.
It is also the most conditional. The population is defined by a list. Partnerships are shut out for the credits that matter most. And the domestic content requirement — which for an ordinary developer costs a ten point adder — costs an applicable entity its entire elective payment on any project beginning construction from 2026, subject to two exceptions that have to be attested under penalties of perjury.
For a municipal utility or a cooperative planning a 2026 start, that makes domestic content the single most consequential procurement decision it will take, and the beginning-of-construction date the single most consequential scheduling one.
The next post closes this sub-series by taking the two mechanisms together: stacking a transfer on top of tax equity, and where the two regimes collide.
Sources: Holland & Knight — Treasury and IRS Release Final Regulations on the Direct Payment of Tax Credits · Reunion — Direct Pay and Domestic Content · Federal Register — Section 6417 Elective Payment of Applicable Credits