March 18, 2024 IRS issues final regulations with few changes on direct-pay elections for certain energy credits under IRC Section 6417 and advanced manufacturing investment credits under IRC Section 48D
Treasury and the IRS have released two sets of final regulations on the direct-pay elections for certain tax credits, which taxpayers can elect to apply as a payment against their federal income tax liabilities. The IRC Section 6417 final regulations (TD 9988) apply to the direct-pay elections for certain energy credits under IRC Section 6417, which was added by the Inflation Reduction Act (IRA) (along with updated frequently asked questions (FAQs)). The IRC Section 48D final regulations (TD 9989) apply to the direct-pay election of the advanced manufacturing investment credit (AMIC), which was enacted by the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act of 2022. Both sets of final regulations adopt the proposed regulations with some modifications (see Tax Alerts 2023-1102 and 2023-1080). The final regulations are stated as generally effective May 10, 2024. The final regulations apply to tax years ending on or after March 11, 2024. For tax years ending before March 11, 2024, taxpayers may choose to apply the final regulations to property that is placed in service after December 31, 2022, as long as the taxpayers apply the rules in their entirety and in a consistent manner. Background IRC Section 6417 direct-pay elections for certain energy credits The IRA provides a direct-pay option for certain credits. Under IRC Section 6417, an "applicable entity" can make a direct-pay election (effectively treating tax credits generated by a renewable energy project as equivalent to taxes paid on a filed return) for certain tax credits, including:
The direct-pay option can only be used by "applicable entities," which generally only include entities exempt from federal tax under subtitle A, state or local governments, the Tennessee Valley Authority, Indian tribal governments or an Alaska Native Corporation. Certain important exceptions to the "applicable entity" limitation exist, however, so any eligible taxpayer can elect direct pay for:
In June 2023, Treasury and the IRS released proposed regulations (REG-101607-23) along with identical temporary regulations on the direct-pay election under IRC Section 6417 (see Tax Alert 2023-1102). The temporary regulations have been removed now that the final regulations have been issued. IRC Section 48D direct-pay elections for advanced manufacturing investment credits IRC Section 48D allows taxpayers to claim the AMIC, which equals 25% of the basis of any qualified property that is part of any taxpayer's advanced manufacturing facility, which is defined as "a facility for which the primary purpose is the manufacturing of semiconductors or semiconductor manufacturing equipment," if the property is placed in service after December 31, 2022. IRC Section 48D does not apply to property constructed after December 31, 2026. Also, for qualified property placed in service after December 31, 2022, whose construction began before January 1, 2023, the AMIC is available only to the extent the property's construction, reconstruction or erection occurred after August 9, 2022. Under IRC Section 48D(d)(1), a taxpayer may elect to treat the AMIC as a payment of federal income tax equal to the AMIC, instead of as a credit against the federal income tax liability for that tax year. A partnership or S corporation may receive a payment instead of a tax credit for property held directly by a partnership or an S corporation. In June 2023, Treasury and the IRS released proposed regulations (REG-105595-23) along with identical temporary regulations on the direct-pay election under IRC Section 48D (see Tax Alert 2023-1080). The temporary regulations have been removed now that the final regulations have been issued. General procedure From a procedural perspective, a direct-pay election generally (1) applies separately to each applicable facility or property, (2) must be made in the first year the facility (or applicable equipment) is placed in service and, (3) applies for the full applicable credit term period, subject to the time-limited direct pay options for certain taxpayers described previously. Certain credits tie the ability to elect direct pay to the satisfaction of the domestic content requirements. Additionally, partnerships or S corporations that directly hold a facility or property eligible for the credit must make the direct-pay election, and it is the partnership or S corporation that receives the direct payment (as opposed to the partners or owners). Finally, an additional 20% penalty may apply to taxpayers receiving "excessive payments." Final regulations Applicable to IRC Section 6417 and IRC Section 48D direct-pay elections Election procedure A direct-pay election may only be made on an original annual tax return, which must be filed by the due date (including extensions) for the original return for the tax year for which the applicable credit is determined, beginning with tax year 2023. Direct-pay elections cannot be made or revised on an amended return or by filing an administrative adjustment request (AAR). Both final regulations modified the proposed regulations by allowing a numerical error to be corrected on an amended return or AAR in certain situations. An error may be corrected on an amended return or AAR if there is a substantive item to correct, not if there is a blank item or an item described as being "available upon request." Pre-filing requirements Under the pre-filing requirements for IRC Sections 6417 and 48D direct-pay elections, taxpayers that want to make a direct-pay election must obtain a registration number for each eligible property by supplying the required information about the applicable credits and property. The information must be submitted through the IRS's registration tool (see Tax Alert 2024-0529). The IRS will review the information and issue a separate registration number for each applicable credit property. The registration number is only valid for one year and must be renewed each year. The registration number must be included on the taxpayer's annual tax return. Once made, the election is irrevocable and applies to any applicable credit for the tax year for which the election is made. According to the Summary of both final regulations, "the documentation to support the existence of valid applicable credit property will vary by the credit being claimed" and is described in the pre-filing registration portal and Publication 5884, Inflation Reduction Act (IRA) and CHIPS Act of 2022 (CHIPS) Pre-Filing Registration Tool User Guide. Denial of double benefit Both final regulations modify the methodology to determine the credit amount for the direct-pay election by changing the ordering of the steps in Treas. Reg. Sections 1.6417-2(e) and 1.48D-6(e) and adding new examples. Under both sets of proposed regulations, the taxpayer would have first computed its federal income tax liability and allowed amount of IRC Section 38 credits (general business credits, GBCs) for the tax year, inclusive of credit carryforwards. The taxpayer would then apply its allowed IRC Section 38 credits against its current year tax liability and determine any amount of excess or unused current-year credits. Finally, the taxpayer would reduce its direct-pay-eligible amount by the amount (if any) allowed as a credit under IRC Section 38. In both final regulations, the IRS agreed with commenters that the ordering rule could result in a lowered elective payment amount. As a result, the final regulations change the ordering rule so a taxpayer will calculate the net elective payment amount prior to applying the ordering rules of IRC Section 38(d). According to the Summary of both regulations, this provision allows a taxpayer that has other GBCs to lower tax liability to the IRC Section 38(c) limitation using those GBCs without impact from the IRC Section 48D or 6417 credit. A taxpayer must use the IRC Section 48D or 6417 credit as a current year GBC to the extent that it is necessary to reduce tax liability up to the limitation under IRC Section 38(c). In all other situations, the IRC Section 48D or 6417 credit will be zero for purposes of IRC Section 38 and the credit will be considered a payment of tax on the later of the due date of the return or filing. Excessive payments If the IRS determines that an excessive payment has been made, the applicable entity's federal income tax for the tax year in which the determination is made increases by the excessive payment plus 20% of the excessive payment. If applicable entities demonstrate that the excessive payment resulted from reasonable cause, the 20% excessive payment penalty will not apply. The IRS said in the Summary of both final regulations that it was not necessary to create new, special rules regarding reasonable cause because existing reasonable cause standards are sufficient to make a determination. The IRC Section 6417 final regulation specified in the Summary that the excessive payment provisions will not apply "if an applicable entity or electing taxpayer amends its tax return or files an AAR before the IRS opens an examination, and the amended return or AAR adjusts the elective payment amount to the amount properly determined with respect to the applicable entity or electing taxpayer." Applicable to IRC Section 6417 direct-pay elections Applicable entities The IRC Section 6417 final regulations adopt most of the proposed regulations' definitions for applicable entities. The final regulations clarify that any tax-exempt organization described in IRC Sections 501 through 530 is an applicable entity eligible to make an elective payment election. The IRC Section 6417 final regulations confirm that partnerships and S corporations are not "applicable entities," even if they are tax-exempt or governments, so they are ineligible for direct pay unless the credits are for carbon capture projects (45Q), the production of clean hydrogen (45V) or advanced manufacturing (45X). These applicable entities can make the direct-pay election if they directly hold the facility or property eligible for the credit, make the direct-pay election and receive the direct payment (as opposed to the partners or owners). The payment is treated as tax-exempt income and allocated to the partners or shareholders based on their share of the credit as determined under Treas. Reg. Section 1.704-1(b)(4)(ii). The income is treated as arising from an investment activity, not from the conduct of a trade or business under IRC Section 469(c)(1)(A), and therefore is not treated as passive income to any partners or shareholders who do not materially participate. An applicable entity may engage with other entities, including with for-profit partners, in certain types of ownership arrangements while preserving their ability to make a direct-pay election under IRC Section 6417(a) for its share of the applicable credits. The IRC Section 6417 final regulations clarified that the ownership share of a party to a transaction will be determined based on the agreement of the parties and other relevant facts and circumstances. The IRS separately issued proposed regulations (REG-101552-24) that would exclude from the partnership rules certain unincorporated organizations to allow them to make elective payment elections. The IRS said in the Summary of the IRC Section 6417 final regulations that the new proposed regulations would provide additional guidance on joint ownership arrangements of applicable credit property that produce electricity that can be excluded from the application of subchapter K. The exceptions generally would allow any applicable entity "that jointly owns applicable credit property that produces electricity to (1) own its interests through an entity (other than an entity required to be treated as a corporation under the Code) and (2) delegate its authority to an agent to sell its share of the electricity produced from such applicable credit property for a period of more than 1 year, provided that the delegation authority to the agent is not for more than 1 year." Chaining elective payments The IRC Section 6417 final regulations confirm that an applicable entity may not "chain" an election for credits under IRC Section 6417 from other sources. Direct-pay elections cannot be made for credits (1) purchased under IRC Section 6418, (2) transferred under IRC Section 45Q(f)(3), (3) acquired by a lessee from a lessor in a pass-through election, or (4) owned by a third party or otherwise not determined directly by the applicable entity or electing taxpayer. To claim the credit, the applicable entity must own the underlying credit property or conduct activities on which the credit it based. The ownership can be direct, through a disregarded entity or through other types of ownership interests where the applicable entity has an undivided interest or share of the underlying eligible facility property. The IRS issued Notice 2024-27 at the same time as the proposed regulations asking for comments on situations in which an elective payment election could be made for a credit that was purchased in an IRC Section 6418 transfer. No excess benefit rule The IRC Section 6417 final regulations have a provision preventing an applicable entity from obtaining an excess benefit. If an applicable entity receives a grant, forgivable loan or other tax-exempt income for the specific purpose of purchasing, constructing, reconstructing, erecting or otherwise acquiring an investment-related credit property, and the sum of that 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 equals the cost of investment-related credit property. Applicable to IRC Section 48D direct-pay elections Partnerships and S corporations Property with respect to which an IRC Section 48D credit is determined is IRC Section 38 property. Treas. Reg. Section 1.704-1(b)(4)(ii) requires allocations of the investment credit provided by IRC Section 38(b)(1) to be made in accordance with the partners' interests in the partnership. It also deems allocations of cost or qualified investment made in accordance with Treas. Reg. Section 1.46-3(f) as made in accordance with the partners' interests in the partnership. Pursuant to Treas. Reg. Section 1.46-3(f)(1), in the case of a partnership that owns IRC Section 38 property, each partner is treated as the taxpayer with respect to the partner's share of the basis of partnership IRC Section 38 property. Under Treas. Reg. Section 1.46-3(f)(2)(i), a partner's share of basis of any IRC Section 38 property is determined in accordance with the ratio in which the partners share general profits. Pursuant to Treas. Reg. Section 1.46-3(f)(2)(ii), each partner's share of the basis of an item of IRC Section 38 property is determined by reference to the allocation effective for the date on which the property is placed in service, rather than in accordance with the ratio in which the partners share general profits:
Thus, Treas. Reg. Section 1.46-3(f), as currently in effect, already permits special allocations of a partner's share of the basis of an item of IRC Section 38 property independent of the ratio in which the partners divide the general profits of the partnership if all requirements under Treas. Reg. Section 1.46-3(f)(2)(ii) are met. Accordingly, the final regulations do not allow a partnership to allocate a partner's distributive share of the IRC Section 48D credit without regard to Treas. Reg. Section 1.46-3(f). The IRC Section 48D final regulations create an interim rule at Treas. Reg. Section 1.48D-6(d)(2)(iv)(B) to address situations in which taxpayers may have entered into written binding partnership agreements for the joint ownership and operation of an advanced manufacturing facility or qualified property before the proposed rules were published in June 2023. According to the Summary, those taxpayers may have made erroneous assumptions that would diminish or negate the benefit of the direct-pay elections if a partner's distributive share under IRC Section 704(b) of the tax-exempt income must be determined in accordance with its distributive share of the otherwise applicable IRC Section 48D credit. The interim rule allows a partner's distributive share of the tax-exempt income described in IRC Section 48D(d)(2)(A)(i)(III) to be determined in accordance with the basic principles for partnership income allocations described in Treas. Reg. Section 1.704-1(b)(1)(i), as opposed to the rules for credits in Treas. Reg. Sections 1.704-1(b)(4)(ii) and 1.46-3(f). This provision applies if a written binding partnership agreement was entered into after December 31, 2021, and before June 22, 2023, and the partnership was formed for the purpose of owning and operating an advanced manufacturing facility or qualified property. BEAT and CAMT Several commenters urged the IRS to make the IRC Section 48D final regulations treat the entire elective payment amount as a payment against tax for purposes of determining base erosion minimum tax (known as the base erosion anti-abuse tax or BEAT) under IRC Section 59A and corporate alternative minimum tax (CAMT) credit under IRC Section 53(c), instead of as an investment tax credit. In contrast with the separate analysis for IRC Section 38 (whereby property for which an IRC Section 48D credit is determined is IRC Section 38 property), Treasury and the IRS concluded that the IRC Section 48D credit would not be directly claimed for purposes of BEAT or CAMT, and treating the elective payment amount as suggested by the commenters would conflict with the IRC Section 48(d)(3) statutory language as to allowable credits. Implications Numerous comments were received on both sets of proposed regulations, but the final regulations mostly adopt and confirm the proposed regulations. These final regulations give taxpayers the necessary clarity on the computational guidelines and compliance requirements for purposes of making the direct-pay elections. The IRC Section 6417 final regulations modify the methodology that must be used to calculate the net elective payment amount by clarifying that the applicable credits must first be used as a GBC to offset federal income tax liability such that only the unused credit amount would be refunded. Importantly, a taxpayer does not need to first apply the IRC Section 38 ordering rules, which may allow taxpayers with significant GBCs or limited federal income tax liability to receive a refund for the entire amount of credit generated during the tax year. Taxpayers seeking to monetize a credit by making a direct-pay election should consider modeling the potential net elective payment as part of their tax planning, taking into consideration their projected current year federal income tax liability. The final regulations did not adopt the numerous comments that wanted Treasury and the IRS to implement different rules to expedite the payment. This means taxpayers have to wait until they file their tax returns and the refunds are processed to receive their IRC Section 6417 payments. Taxpayers will need to model into their project economics the lag between cash outflows to build the facility and cash inflows from the direct payment. In the case of IRC Sections 45Q, 45X and 45V, taxpayers should consider evaluating whether transferring the credits under IRC Section 6418 and receiving the proceeds earlier is more advantageous than waiting for the direct payment.
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