IRS and Treasury issue final section 45X regulations

On Oct. 28, 2024, the Treasury and the IRS published final regulations for the section 45X advanced manufacturing production credit. This credit incentivizes the production of certain eligible components within the United States or a United States territory. The final regulations contain revisions not included in the proposed regulations. Perhaps the most significant revision in the final regulations was the addition of certain production costs includible in the section 45X credit calculation for electrode active materials and critical minerals. Other notable revisions were made to the rules for contract manufacturing arrangements and eligible production.

Overview

The Inflation Reduction Act of 2022 (“IRA”) added section 45X to the Internal Revenue Code to incentivize the production and sale of eligible components and critical minerals. Eligible components include solar, wind,  battery components and inverters. Section 45X lists 50 critical minerals the production of which is eligible for the credit. Except for electrode active materials and critical minerals, the credit rate for the production and sale of eligible components is generally a rate per component listed in the statute. For electrode active materials and critical minerals, taxpayers eligible for the section 45X credit may claim a credit of 10% of certain production costs.

In general, to be eligible for the section 45X credit, a taxpayer must be responsible for the production of eligible components or critical minerals meeting certain standards and must sell the component or critical mineral to an unrelated taxpayer. The final regulations provide rules for these eligibility factors.

Production costs

The proposed regulations would not have allowed certain direct and indirect material costs to be included in a taxpayer’s section 45X credit calculation. Among the excluded costs were costs paid or incurred for the extraction of raw materials. The rules on production costs were modified in the final rules. Under the final regulations, production costs may include direct and indirect material costs associated with manufacturing eligible components but only if they do not relate to the purchase of materials that are an eligible component at the time of acquisition. Further, costs paid or incurred for the extraction of raw materials in the United States or a United States territory may be eligible for inclusion in production costs, provided they are paid or incurred by the taxpayer claiming the section 45X credit.

Eligibility: Contract manufacturing and substantial transformation

With respect to eligible components, one requirement of taxpayers claiming a section 45X credit is they must be responsible for the actual production activities that bring about a substantial transformation resulting in an eligible component.

Contract manufacturing

Both the proposed and final regulations address these production activities that may occur in contract manufacturing arrangements. The proposed rules were generally unchanged in the final rules except for minor clarifications. For example, the final regulations added an example to demonstrate the intersection of contract manufacturing arrangements and extraction of raw materials for some section 45X credit claimants.

Substantial transformation: Minor versus mere assembly

The proposed regulations used the terms minor assembly and mere assembly to describe activities that did not rise to the level of substantial transformation required for a taxpayer to be eligible for the section 45X credit. Analyzing production activities that involve the substantial transformation of constituent elements or materials involves a facts and circumstances approach. For some activities, the final regulations provide more specific guidance. For example, assembly is the primary activity that results in some eligible components, such as solar modules and battery modules using battery cells. The final regulations clarify that these activities generally should not be viewed as minor assembly disqualified from eligibility. For consistency, the final regulations also only use the term minor assembly, eliminating the term mere assembly, to distinguish activities that do not preclude a taxpayer from being eligible for the section 45X credit.

Washington National Tax takeaways

The section 45X credit has stimulated investment in domestic manufacturing of components needed in the clean energy supply chain such as wind, solar, and battery components, as well as the critical minerals required to make these components. Many new facilities have been opened or planned to produce eligible components.  With respect to monetization of this credit, the market is strong. We continue to see 45X credits being sold in the marketplace at high pricing because of the low risk of recapture and straightforward aspects for this credit.

With respect to future tax policy and the change in administration, President-elect Trump has a stated focus on increasing domestic manufacturing. The 45X credit has stimulated new investments in states across the country, particularly in areas with a strong Republican constituency. Accordingly, we could potentially see favorable modifications to the 45X credit in the coming administration, such as expansion to include new eligible components.  However, there could also be modifications to limit the credit with respect to certain foreign-owned facilities; the current rules have no such limitations.

Finalizing the section 45X regulations in a taxpayer favorable manner is important to provide certainty to taxpayers looking to invest in the United States. The final regulations under section 45X offer minor adjustments 4Rules concerning production and sales continue to be critical for taxpayers documenting their eligibility for the section 45X credit. Before calculating a potential credit, taxpayers should work with a tax advisor to review and document their eligibility for the credit.