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In final regulations (TD 9995), the IRS clarified the requirements for new and used clean vehicle tax credits under IRC Sections 30D and 25E. The final regulations adopt the proposed regulations for the most part but modify the requirements for determining whether the battery components and applicable critical minerals contained in a vehicle battery are foreign-entity-of-concern (FEOC) compliant. They also extend the time to comply with the new rule until January 1, 2027.

The Treasury and IRS received over 180 comments in response to the proposed regulations and a public hearing was held on January 31, 2024.

Background

The IRA modified the IRC Section 30D "new qualified plug-in electric drive motor vehicles credit" to a "clean vehicle credit." The non-refundable clean vehicle credit is a dollar-for-dollar reduction of federal income taxes by up to $7,500 for new clean vehicles acquired and placed in service by a taxpayer during the tax year before January 1, 2033.

To be eligible for a credit under IRC Section 30D, the clean vehicle must satisfy certain requirements, including the following: (1) the original use of the clean vehicle must commence with the taxpayer, (2) the clean vehicle cannot be acquired for resale, (3) the clean vehicle must be made by a qualified manufacturer, and (4) the final assembly of the clean vehicle must occur in North America.

The IRC Section 30D credit can reach $7,500, so long as the sourcing requirements are satisfied for both the critical minerals and battery components contained in the clean vehicle's battery. The credit consists of two parts. For vehicles placed into service after April 17, 2023, taxpayers' eligibility for the first $3,750 of the credit depends on the percentage of the critical minerals that were either extracted or processed in the United States (or extracted or processed in any country with which the United States has a free trade agreement in effect) or recycled in North America. The applicable percentage is 40% for vehicles placed in service before 2024, with the percentage increasing to 80% for vehicles placed into service after December 31, 2026. Taxpayers' eligibility for the remaining $3,750 of the credit depends on the applicable percentage of the value of the battery components that were manufactured or assembled in the United States. The applicable percentage is 50% for clean vehicles placed in service before 2024, with the applicable percentage increasing to 100% for vehicles placed in service after December 31, 2028.

For vehicles placed in service after December 31, 2023, the credit will not apply for battery components sourced from FEOCs (see Tax Alert 2023-2073). A similar limitation for critical minerals takes effect on January 1, 2025.

For the credit to apply, the manufacturer's suggested retail price (i.e., sticker price) for a vehicle may not exceed a specified threshold (e.g., $80,000 for vans, SUVs and pickup trucks, $55,000 for sedans and others). Limitations on a taxpayer's adjusted gross income also apply. Taxpayers may elect to transfer credits to an eligible dealer subject to certain requirements. Additionally, certain recapture rules apply.

Previous guidance

The IRS and Treasury previously released proposed regulations on determining whether clean vehicles comply with the critical mineral and battery component requirements to qualify for the IRC Section 30D credit (see Tax Alerts 2023-2073, 2023-0660, 2023-2073). The IRS also released guidance on qualifying for the credits and transferring them (see Tax Alerts 2022-1262, 2023-0076, 2023-0251, 2023-1723).

Final regulations

The final regulations generally adopt the proposed regulations with some clarifications of the definitions of the various requirements. The final regulations clarify that vehicles that may qualify as previously-owned clean vehicles include battery electric vehicles, plug-in hybrid electric vehicles, fuel cell motor vehicles and plug-in hybrid fuel cell motor vehicles.

The final regulations address a variety of topics, including:

• Creating a new test to determine whether the battery components meet the critical minerals test while giving manufacturers two more years to comply with the new test
• Adding a new definition of "battery materials"
• Updating the definition of a manufacturer to allow upfitters, which are defined as manufacturers that modify a new vehicle into either a new clean vehicle or a qualified commercial clean vehicle
• Making the allocation-based determination a permanent option for determining FEOC compliance for qualified manufacturers
• Defining impracticable-to-trace battery materials to include graphite contained in anode materials (both synthetic and natural) and applicable critical minerals contained in electrolyte salts, electrode binders, and electrolyte additives

The impracticable-to-trace battery materials can be exempt from FEOC compliance until 2027 if a manufacturer submits a report demonstrating how it would comply with the FEOC restriction at the end of the transition period.

Critical minerals test

The final regulations adopt the Department of Energy (DOE) definition of FEOC from the proposed regulations. In determining whether the battery components comply with the critical minerals test, the final regulations require taking into account each step of extraction, processing or recycling through the step in which the mineral is processed or recycled into a constituent material, even if the mineral is not in a form listed in IRC Section 45X(c)(6) at every step of production. A critical mineral is disregarded for purposes of Treas. Reg. Sections 1.30D-3(a) and 1.30D-6 if it is fully consumed in the production of the constituent material or battery component and no longer remains in any form in the battery.

The final regulations create the Traced Qualifying Value Test to replace the 50% Value Added Test. The new test is more stringent because it requires a manufacturer to fully trace any value added in each procurement chain and only treat a percentage of the value of an applicable critical mineral as qualifying. The Traced Qualifying Value Test also allows for each incremental increase in value-added activities to be included, as opposed to the 50% cliff effect under the Value Added Test. Under the 50% cliff effect, the value of applicable critical minerals just below the threshold percentage is not applied toward the critical minerals requirement while the full value of applicable critical minerals just above the threshold percentage is treated as qualifying.

The Traced Qualifying Value Test requires a manufacturer to first determine separately the procurement chain for each portion of a qualifying critical mineral. A procurement chain is defined in Treas. Reg. Section 1.30D-3(c)(1)(i) as a "common sequence of extraction, processing, or recycling activities that occur in a common set of locations with respect to an applicable mineral, concluding in the production of constituent materials."

Second, the manufacturer must determine the "traced qualifying value" of all applicable critical minerals" and the "total traced qualifying value," which are defined in Treas. Reg. Section 1.30D-3(c)(1)(vii), to determine what percentage of the minerals were (1) extracted or processed in the United States, or in any country with which the United States has a free trade agreement in effect or (2) recycled in North America. The final regulations list the countries with which the United States currently has free trade agreements: Australia, Bahrain, Canada, Chile, Colombia, Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Israel, Japan, Jordan, Mexico, Morocco, Nicaragua, Oman, Panama, Peru, Singapore and South Korea.

Third, a manufacturer must calculate critical mineral content by dividing the total traced qualifying value by the total value of critical minerals.

The final regulations require manufacturers to select a date for determining the total traced qualifying value and the total value of critical minerals as of the final processing or recycling of the applicable critical mineral. The date must apply uniformly to all the applicable critical minerals in the clean vehicle battery.

Transition rule

The final regulations give manufacturers the option of using the 50% Value Added Test as a transition rule for vehicles for which a periodic written report is provided after the final regulations are published in the Federal Register, but before January 1, 2027.

Battery materials

The final regulations add a new definition of battery materials, which is defined as direct and indirect inputs to battery components that are produced through processing, rather than manufacturing or assembly. Battery materials are not considered a type of battery component, although battery materials may be manufactured or assembled into battery components.

Effective dates

The IRC Section 25E final regulations generally apply to tax years ending after October 10, 2023. The IRC Section 30D final regulations generally apply to tax years ending after December 4, 2023.

Implications

The final regulations clarify several issues, such as the requirements for critical minerals and battery components and determining compliance with those requirements. Manufacturers will have to make significant changes in their procurement processes to track and confirm whether vehicles meet the requirements. The regulations also require increased transparency between suppliers and manufacturers, which could create challenges with data sharing. It is important for manufacturers and suppliers to utilize the transition period to implement changes to their procurement and data reporting processes so their vehicles qualify for the tax credits.