Executive summary: Proposed and temporary regulations
Section 6417 was added to the Internal Revenue Code (Code) by the Inflation Reduction Act (the IRA), allowing for the elective payment (also referred to as direct pay) of applicable credits. The IRA gives certain tax-exempt organizations, referred to as ’applicable entities’ access to the economic benefit of energy-related credits via elective payments. In addition, the applicable entities under section 6417 also include certain taxable entities wishing to take advantage of the direct pay option for tax credits under sections 45V, 45Q, or 45X. Applicable entities can elect to receive elective payments for taxable years beginning after Dec. 31, 2022.
The IRA also added section 6418 which provides taxpayers other than applicable entities to make an election to transfer all or a portion of ’eligible credits’ to another taxpayer in exchange for cash. Direct pay under section 6417 and transferability under section 6418 will afford certain non-taxpaying and taxpaying entities new options for monetizing the economic benefits of clean energy credits. Eligible entities may begin transferring credits under section 6418 for taxable years beginning after Dec. 31, 2022.
The advanced manufacturing investment credit under section 48D is available for certain capital expenditures integral to the operation of the advanced manufacturing facility. Such a facility’s primary purpose is the manufacturing of semiconductors or semiconductor manufacturing equipment. In order to encourage investment in the semiconductor industry, section 48D has an election for taxpayers to receive a payment in lieu of the credit. The section 48D guidance spells out the registration process to qualify for the payment.
On June 14, 2023, the IRS and the Department of the Treasury (Treasury) released four pieces of guidance related to both the elective payment of applicable credits under section 6417 and the transfer of certain credits under section 6418. The four pieces of guidance include three notices of proposed rulemaking (proposed regulations) and notices of public hearing regarding the elective payment of applicable credits, the transfer of certain credits, and the elective payment of advanced manufacturing investment credit as well as temporary regulations regarding the pre-filing registration requirements for certain tax credit elections. The IRS also released an FAQ on direct pay and transferability.
Treasury and the IRS released temporary and proposed regulations on the rules for using direct pay or transferability to monetize certain Federal income tax credits. The guidance includes new and complex developments for taxpayers to consider when planning energy projects. This article examines several of these developments but is not all-encompassing. Taxpayers should work with their tax advisors to consider these temporary and proposed regulations in more depth.
IRS and Treasury release guidance on the monetizing energy credits
Pre-filing registration requirements
The IRS released temporary regulations on June 14, 2023, detailing pre-filing registration requirements for the elective payment and transfer of credits in sections 48D, 6417, and 6418. These temporary regulations describe specific information and registration requirements for qualified taxpayers planning on taking advantage of the elective payment election and transferability election options created by the IRA and the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act of 2022. The advanced manufacturing investment credit under section 48D has the elective payment election included within the credit, whereas section 6417 creates an election for twelve other energy-related credits.
These temporary regulations apply to taxable years ending on or after the date of publication in the Federal Register which, per the IRS, is scheduled for June 21, 2023. The temporary regulations under sections 48D, 6417, and 6418 all expire on June 21, 2023. Both direct pay and transferability apply to taxable years beginning after Dec. 31, 2022.
The temporary regulations provide that an applicable entity or a qualifying electing taxpayer must complete the mandatory pre-filing registration. After the IRS reviews the pre-filing registration, the IRS will then issue a registration number. A registration number is necessary to qualifyfor the elective payment election under sections 48D or 6417 or an election to transfer credits under section 6418. The pre-filing registration must be completed electronically through an IRS electronic portal which is expected to be available by fall 2023. Registration numbers are only valid for one year and for the taxable year for which it is obtained.
Specific to section 48D elective payments, the temporary regulations provide that a taxpayer must register each qualified investment in an advanced manufacturing facility for which a section 48D credit will be claimed through direct pay and must report a separate valid registration number for each advanced manufacturing facility on the tax return for the taxable year of the elective payment election. This is mirrored in the temporary regulations under section 6417 which require each applicable credit property for which the applicable entity or electing taxpayer intends to make an elective payment election to have its own registration number and report those registration numbers on the tax return for the taxable year of the elective payment election.
Similar rules are implemented by the temporary regulations under section 6418. A credit transferee must also include the registration number of the eligible credit property on their tax return for the taxable year that the transferee taxpayer takes the transferred specified credit portion into account.
The temporary regulations provide the information required to complete the pre-filing registration process for sections 48D, 6417, and 6418 and steps to complete such process. It is important to note that completion of the pre-filing registration requirements and receipt of a registration number does not, by itself, guarantee a taxpayer’s eligibility to receive a payment under sections 48D and 6417 or to transfer credits under section 6418. However, failure to follow these pre-filing registration requirements will render such elections ineffective.
Elective payment under section 6417: Direct Pay
In general, section 6417 allows an applicable entity to make the election to treat any applicable credit as a payment against tax imposed by subtitle A (i.e., federal income taxes) for the applicable tax year in an amount equal to the credit.
The following Federal income tax credits are ’applicable credits’ eligible for the elective payment under section 6417(b).
- Alternative fuel vehicle refueling property credit under section 30C
- Renewable electricity production credit under section 45
- Zero-emission nuclear power production credit under section 45U
- Credit for qualified commercial clean vehicles determined under section 45W (direct pay is only available for a subset of applicable entities for the qualified commercial vehicles credit)
- Clean electricity production credit determined under section 45Y
- Clean fuel production credit determined under section 45Z
- Energy credit under section 48
- Qualifying advanced energy project credit determined under section 48C
- Clean electricity investment credit determined under section 48E
The following applicable credits also allow for entities other than applicable entities to elect into the direct pay provision for a period of time (electing entities).
- Credit for carbon oxide sequestration under section 45Q
- Credit for production of clean hydrogen under section 45V
- Credit for advanced manufacturing production under section 45X
The following entities are applicable entities under section 6417(d)(1)(A).
- Any organization exempt from the tax imposed by subtitle A,
- Any State or political subdivision thereof,
- An Indian tribal government (as defined in section 30D(g)(9)),
- Any Alaska Native Corporation (as defined in section 3 of the Alaska Native Claims Settlement Act (43 U.S.C. 1602(m)),
- The Tennessee Valley Authority,
- Any corporation operating on a cooperative basis which is engaged in furnishing electric energy to persons in rural areas; or
- Any agency or instrumentality of any U.S. territory governments, any States, the District of Columbia, or an Indian tribal government.
Clarification of applicable entities
The regulations propose to define the term ’any organization exempt from the tax imposed by subtitle A’ to include all organizations exempt from the tax imposed by subtitle A by section 501(a). These entities are commonly referred to as ’tax-exempt organizations.’However, entities that have tax-exempt status under State law but do not have Federal tax-exempt status will be excluded from the definition of applicable entities.
The regulations propose that ’any state of political subdivision thereof’ will include the District of Columbia. The proposed regulations also clarify that this term will include agencies and instrumentalities of any State, the District of Columbia, Indian tribal governments, U.S. territories, or political subdivisions thereof. This expanded definition confirms that State agencies and instrumentalities such as public universities qualify for direct pay.
The proposed regulations closely follow the statute and do not expand the term to include certain Alaska Native Corporation Settlement Trusts. However, the Settlement Trusts may still qualify as applicable entities so long as they are granted tax-exempt status under section 501(a).
No chains of monetized credits
The proposed regulations confirm that transferred credits are ineligible for the direct pay provision under section 6417and cannot be transferred more than once. The proposed regulations permit transferring credits through a broker as long as the broker does not take title to the transferred credit.
Elective payments are to be claimed on an applicable entity’s annual tax return, including Form 1065 for electing taxpayers and Form 990-T, after completion of the pre-filing registration requirements. However, not all applicable entities are required to file an annual income tax return. To claim elective payments, such entities would be asked to file a tax return for this purpose. Applicable entities located in the U.S. territories must use the tax return they would be required to file if they were located in the United States. Other entities without a return filing requirement must use Form 990-T. Short tax year filers must use the short year tax return.
Partnerships and S corporations with applicable entity shareholders
The proposed regulations clarify that partnerships and S corporations are not applicable entities. Accordingly, the possibility for applicable entities to claim elective payments through a partnership is limited. Partnerships or S corporations with one or more applicable entity shareholders may instead consider transferring eligible credits under section 6418. There may be other opportunities, such as through a joint venture that has properly elected out of subchapter K, for applicable entities to make elective payments. In addition, partnerships and S corporations have some additional filing requirements to elect direct pay for sections 45V, 45Q, or 45X.
Transfer of credits under section 6418: Sale of credits
Section 6418 allows taxpayers other than ’applicable entities’ to make an election to transfer all or a portion of ’eligible credits’ to an unrelated taxpayer in exchange for cash. Consideration for the credit shall not be included in gross income for the transferor taxpayer; the payment will not be deductible by the transferee taxpayer. In general, the list of eligible credits contains the same credits as the list of applicable credits for purposes of section 6417 except for the credit for qualified commercial clean vehicles under section 45W. The proposed regulations under section 6418 provide clarity in several areas regarding the transfer of certain credits.
Transfer of certain partners’ credits
The proposed regulations allow partnerships and S corporations to transfer a specified portion of eligible credits which is a proportionate share (including all) of an entire eligible credit. The proposed regulations provide steps for partnerships to determine the proportionate share that is allocable to each shareholder, allowing partnerships to transfer a portion or all of each partner’s eligible credit amount.
Treatment of proceeds from a transfer
A transferor’s proceeds from the sale of an eligible credit is tax-exempt income. The proposed regulations would treat the tax exempt income resulting from an elective payment election by a partnership or an S corporation as arising from an investment activity and not from the conduct of a trade or business within the meaning of section 469(c)(1)(A) . In contrast, the proposed regulations would treat the eligible credit as earned in connection with the conduct of a trade or business for transferee taxpayers. As such, the transferred credit would be subject to passive limitation rules under section 469 for transferee taxpayers.
Cash consideration requirement
Eligible credits may only be transferred in exchange for cash. The proposed regulations provide clarity on the definition of cash and the timing of payments in this context. Electronic payments of United States dollars will be permitted in addition to physical currency. Advance payments generally will not be permitted.Transfers must take place no earlier than the start of the taxable year for which an eligible credit is determined and no later than the due date for completing a transfer election statement.
Washington National Tax takeaways
The rules for pre-filing registrations and for making electrive payments or credit transfers are complex, especially when a partnership or S corporation is involved as a transferor or transferee. Taxpayers should carefully consider these rules when modeling monetization options for certain energy credits. Depending on a taxpayer’s facts, the rules in these proposed and temporary regulations may create or reduce barriers for the monetization of certain credits. Please consult an advisor to discuss the impact the proposed and temporary regulations may have on monetizing the credits under the IRA and the CHIPs Act.