The Inflation Reduction Act of 2022 created new opportunities both in renewed and brand-new energy tax credits. It also offered new methods through which these credits can be claimed, as a Section 6417 direct payment to eligible tax-exempt entities (Direct Pay) or through a section 6418 transfer of a credit from one taxpayer to another for cash payments (Transfer).
On June 14, 2023, the IRS and Treasury Department released a series of proposed and temporary regulations detailing how to elect for Direct Pay or Transfer, including a registration process designed to prevent fraud, duplication, and improper or excessive payments from occurring through these methods. The IRS also issued a series of FAQs offering much-needed clarity for taxpayers seeking to make use of the Inflation Reduction Act’s expanded benefits for pursuing specified renewable energy and manufacturing activities.
(Note that proposed and temporary regulations were also issued for direct payment credits under Section 48D for the manufacture of semiconductors and semiconductor manufacturing equipment in the United States; however, that is outside the scope of this alert.)
This alert summarizes the key points of the Direct Pay guidance and the related portions of the pre-filing registration guidance. A previous alert, “IRS Issues Guidance for Transferability of Energy Tax Credits,” discussed the Transfer guidance.
Subject to a taxpayer’s substantive qualification, the following tax credits qualify for Direct Pay or Transfer under the Inflation Reduction Act (IRA).
|Section 30C – Alternative Fuel/EV Charger Credit||Section 45X– Advance Manufacturing Production Credit|
|Section 45/45Y – Production Tax Credit|| Section 45Z – Clean Fuel Production Credit |
|Section 45Q – Tax Credit for Carbon Sequestration||Section 48/48E – Investment Tax Credit|
|Section 45U – Nuclear Power Production Credit|| Section 48C – Advanced Manufacturing Tax Credit |
|Section 45V – Clean Hydrogen Production Credit|
*Note: This credit is available for Direct Pay, but not Transfers.
Proposed Regulations on Section 6417 Direct Pay
Direct Pay through Section 6417 allows a selected group of nontaxable entities to make use of energy tax credits that they previously had only limited or no opportunity to use. This group specifically includes tax-exempt organizations, U.S. state or municipal governments (or their political subdivisions), the Tennessee Valley Authority, Indian tribal governments, Alaska Native corporations, and rural energy co-ops (Direct Pay Eligible Taxpayers). The proposed regulations generally have an expansive take on including entities within this defined group with an emphasis on not creating unnecessary review burden on the IRS. The credits in Sections 45Q (carbon capture and sequestration), 45V (clean hydrogen) and 45X (advanced manufacturing production credit) are also available for Direct Pay to other taxable “electing taxpayers” that do not fall into the group of Direct Pay Eligible Taxpayers, but only for a five-year election period. Disregarded entities qualify (or disqualify) for Direct Pay based on the characteristics of their first regarded parent entity.
- Direct Pay Application to Partnerships and S Corporations
One of the most discussed open questions was whether partnerships and S corporations that are owned by Direct Pay Eligible Taxpayers could participate in Direct Pay. The proposed regulations seek to close the debate on this matter by definitively stating that passthrough entities are not Direct Pay Eligible Taxpayers, regardless of whether any or even all the entity’s owners are Direct Pay Eligible Taxpayers. This means that passthrough entities cannot elect to participate in general Direct Pay, but may receive five-years of direct payments as electing taxpayers for Sections 45Q, 45V, and 45X and they may also elect to Transfer (and thus sell) tax credits under Section 6418. The guidance gives three reasons for this restrictive position: (i) Section 6417(c) requires the election to be made at the partnership or S corporation (i.e, the property owner) level, (ii) partnerships and S corporations are not included in the statute’s list of Direct Pay Eligible Taxpayers, and (iii) that breaking up the tax credit between Direct Pay elections and other treatment among passthrough owners would be difficult to administer.
This rule excludes Direct Pay Eligible Taxpayers from claiming Direct Pay while participating in passthrough structures, except in very limited circumstances where the passthrough elects out of passthrough treatment in favor of undivided co-ownership. This is a somewhat surprising development, given that the Direct Pay statute has a section explicitly devoted to partnership and S corporation elections, which does not seem designed to be this limiting. Undoubtedly, this position will inspire more debate during the notice and comment period for these Direct Pay proposed regulations.
- Tax Credit Basis Under Direct Pay
One of the key features of Section 6417 is that it turns off the general restrictions on nontaxable entities claiming energy credits. Typically, tax credit benefits may be claimed only by taxpayers that use credit-eligible property in a trade or business. The statute and these proposed regulations clarify that Direct Pay Eligible Taxpayers are treated as if they meet these trade or business rules.
Additionally, typically when taxpayers pay for the construction or acquisition of credit-eligible property with tax-exempt financing, they must reduce the basis of that property when claiming an investment credit (that is, Sections 30C, 45W, 48, 48C or 48E credits). However, these proposed regulations do not require that basis reduction for Direct Pay Eligible Taxpayers in recognition that these entities are often the primary consumers of grants, forgivable loans and other tax-exempt financing. If the standard basis-reduction rules applied, many Direct Pay Eligible Taxpayers would end up with little or no tax credit basis to claim under Direct Pay. However, to prevent an excessive benefit, the proposed regulations require that the applicable Direct Pay credit cannot exceed the Direct Pay Eligible Taxpayer’s cost of the investment credit property. For example, a tax-exempt nonprofit receives a $100,000 grant and uses that grant plus $40,000 of its discretionary cash to build a solar energy generation system that qualifies for a 30% Section 48 investment tax credit of $42,000. The nonprofit can claim only $40,000 of the credit under Direct Pay.
- Stacking Direct Pay and Transfer Credits
Another open question was whether a Direct Pay Eligible Taxpayer could stack together the elections for Direct Pay and Transfers, effectively allowing an entity to buy credits at a discount under the Transfer rules and then make a Direct Pay election for the full credit amount. The proposed regulations unsurprisingly forbid this by requiring all Direct Pay (and Transfer) elections to be made by the entity that owns the underlying eligible credit property or, if ownership is not required (such as in certain production tax credits), an election by the party that otherwise conducts the activities giving rise to the underlying credit. The Treasury Department and the IRS note that they will seek further comment on the issue, but their position seems unlikely to change, given the difficulty to administer this and its obvious departure from the policy goals of the IRA.
- Timing for Direct Pay Claims
Direct Pay Eligible Taxpayers must register their Direct Pay credits under the rules of the temporary regulations discussed below. Once registered, a Direct Pay election must be made with the Direct Pay Eligible Taxpayer’s annual tax return filing or, if not a regular tax filer, on the due date for the applicable annual return. For example, a tax-exempt entity must file with a Form 990-T as if it had an annual return filing obligation for unrelated business taxable income. Direct Pay claims must be made on a Form 3800 for the General Business Credit (or such successor forms that the IRS prescribed). Importantly, claims must be made on an original return, not on an amended return. The due date of an original return can be extended, and an original return includes a superseding return filed on or before the due date, but no relief will be granted for missed elections after a return due date.
Temporary Regulations on Pre-Filing Registration for Direct Pay
The pre-filing rules for Direct Pay are generally congruent with those for Transfers. Eligibility is contingent upon the Direct Pay Eligible Taxpayer completing the filing process, obtaining a registration number from the government and reporting the registration number on the entity’s annual tax return. Completion of the pre-filing registration requirements and receipt of a registration number do not, by themselves, mean the taxpayer is eligible for Direct Pay. Ultimately, eligibility is determined under the substantive technical rules granting the specific energy credit.
The broad pre-filing parameters are as follows:
- Those intending to elect a credit Direct Pay must file through an IRS‑provided electronic portal (to be established by fall 2023).
- The election cannot be made until the registration requirements have been completed and the IRS has issued a registration number.
- Each applicable credit-bearing property or activity must have its own registration number.
- The required identifying information must be provided before the registration will be processed by the IRS, including certain amendment and renewal requirements.
Unless modified in future guidance, these temporary regulations establish the definitive list of required identifying information. The pre-filing information that must be provided is as follows:
- General identifying information (name, address, taxpayer identification number and type of legal entity).
- IRS-prescribed eligibility information, to be provided in the portal instructions (such as entity information or information regarding the relevant exempt status).
- The entity’s tax year.
- The type of tax return normally filed, or normal non-filing status.
- The type of credit(s) being claimed or transferred.
- Details about the credit-eligible property or project, such as (a) property type, (b) physical location, (c) supporting documents on the construction or acquisition, (d) dates of beginning construction and placing in service, and (e) source of funding if an investment-related credit.
- The contact person with authority to bind the entity.
- A penalties-of-perjury statement.
- Any other information the IRS deems necessary to prevent fraud, duplication, and improper or excessive payments.
The pre-filing registration process allows for renewals and amendments, so a project owner or developer can apply for a registration number speculatively and adjust if the project is not completed as expected. Each registration number is valid for use with respect to the specific taxpayer or tax-exempt entity that received it, and it is valid for only one specific tax year. If the election is not made for the specified year, the recipient can renew the registration for a subsequent taxable year according to applicable instructions, including attesting that all the facts previously provided are still correct or updating any facts as needed. Similarly, if the recipient of the registration number changes, such as through an acquisition, the original recipient must amend the application and the new owner must separately submit a new registration.
Notice and Comment on the Proposed and Temporary Regulations
The proposed and temporary regulations will be published in the Federal Register on June 21, 2023.
The Section 6417 Direct Pay proposed regulations may be relied upon for taxable years beginning after Dec. 31, 2022, but are subject to a notice and comment period before they will be made final. Interested parties are requested to submit comments by Aug. 14, 2023.
The pre-filing temporary regulations (at TD 9975) are made immediately effective without notice and comment, distinct from the proposed regulations discussed above. The IRS and Treasury mindfully assert that these mechanical registration activities need to be in place before fall 2023 to permit filers to take advantage of the Direct Pay provisions for their 2023 tax years, and to allow the IRS to begin the process of reviewing information that will prevent duplicate, fraudulent, improper, or excessive transfers or payments. However, the IRS and Treasury will accept comments on these temporary regulations along with the proposed regulations and they will be considered before any final regulations are issued.