United States: Treasury And IRS Release Long-Awaited Guidance On Direct Pay And Transferability Elections

On June 14, 2023, Treasury and the IRS released several important and highly-anticipated pieces of guidance regarding the monetization of certain renewable energy tax credits that were enacted by the Inflation Reduction Act and the CHIPS Act using so-called direct payment and transferability elections.

The CHIPS Act enacted an advanced manufacturing investment credit under section 48D. Under section 48D(d), taxpayers are permitted to make an election that treats the tax credit as a direct payment of tax, which can give rise to a refundable overpayment of tax if the taxpayer does not have sufficient tax liability to use the credit (a "direct payment").

The Inflation Reduction Act made many modifications to renewable energy tax credits, including adding new monetization provisions in sections 6417 and 6418. Section 6417 permits certain taxpayers to make a direct payment election for certain credits:

i. alternative fuel vehicle refueling property credits under section 30C;

ii. renewable electricity production credits under section 45;

iii. carbon oxide sequestration credits under section 45Q;

iv. zero-emission nuclear power production credits under section 45U;

v. credits for production of clean hydrogen under section 45V;

vi. credits for qualified commercial vehicles under section 45W;

vii. credits for advanced manufacturing production under section 45X;

viii. clean electricity production credits under section 45Y;

ix. clean fuel production credits under section 45Z;

x. energy investment tax credits under section 48;

xi. qualifying advanced energy project credits under section 48C; and

xii. clean electricity investment credits under section 48E.

This direct payment election is not broadly available to all taxpayers and generally only applies to certain tax-exempt organizations, state or local government entities, the Tennessee Valley Authority, an Indian tribal government, or an Alaska Native Corporation. However, the election applies to all taxpayers for section 45Q carbon capture credits and to the new credits for clean hydrogen in section 45V and clean energy manufacturing in section 45X, but generally only for the first five years of the credit period, after which the credits again become nonrefundable for those taxpayers.

Section 6418 generally permits credits otherwise allowable to taxpayers that are not eligible for the direct payment election described above to elect to transfer all or a portion of their credits for any taxable year to an unrelated taxpayer. Any payment made by the transferee taxpayer would not be deductible to the transferee nor includable as income for the transferor.

The proposed and temporary regulations released on June 14 provide guidance on the direct payment elections under section 48D(d) and section 6417 and on the transfer election under section 6418. Treasury and the IRS previously released Notice 2022-50 requesting comments on sections 6417 and 6418 and received over 200 comments, which it tried to address in the proposed regulations. The proposed regulations have a 60-day comment period, so comments are due on August 14.

Section 6417 Direct Payment Election

• An applicable entity may make a direct payment election with respect to any applicable credit determined with respect to such applicable entity.
  • The proposed regulations include governments of U.S. territories as well as agencies and instrumentalities of various governments in the definition of applicable entity.
  • Partnerships and S corporations cannot be applicable entities, no matter how many of the partners or owners are applicable entities, but they can make the election for certain credits below.
  • Applicable credits include both the base amount and any bonus credits under sections 30C, 45(a), 45Q(a), 45U(a), 45V(a), 45W, 45Y, 45Z, 48, 48C, and 48E.
• Taxpayers that are not applicable entities may make a direct payment election for certain credits.
  • The election is made by partnerships or S corporations and not the partners or shareholders.
  • The election is made separately for each applicable credit property, which is a single process train for section 45Q, a clean hydrogen facility for section 45V, or a facility that produces eligible components for section 45X.
  • The election applies for the taxable year in which an election is made and each of the four succeeding taxable years that end before January 1, 2033. The election period cannot be less than a taxable year, unless it is a short taxable year within the meaning of section 443.
  • Generally, elections have to be made in the year that the property, facility, or equipment is placed into service, which essentially means that the direct payment election applies for the first five years of the credit period. However, with respect to the section 45X credit, the taxpayer can make the election in any taxable year after December 31, 2022 in which the taxpayer manufactures eligible components.
  • The election can only be made if the pre-filing registration is complete and can only be made for each succeeding year if all requirements have been met each year.
• Chaining of elections is not permissible.
  • Thus, for example, an applicable entity may not make a direct payment election with respect to credits it purchased under section 6418, credits transferred pursuant to section 45Q(f)(3), or credits acquired by a lessee from a lessor by means of an election to pass through the credit to a lessee under section 50(d)(5).
• The election is generally made as part of the annual tax return, including Form 3800, General Business Credit and reporting the registration number.
  • Generally, the elective payment will be treated as made on the date that a return is due or the date on which a return is filed or whichever is later depending on the taxpayer's status.
  • The proposed regulations do not contain a special rule relating to quarterly estimated payments, but the preamble notes that taxpayers can take into account their projected annual tax liability in computing their estimated taxes and estimated tax penalties.
  • The election can only be made on a timely filed original return (including extensions), not on an amended return.
  • There is no late election relief under Treas. Reg. §§ 301.9100-1 through 301.9100-3.
  • The applicable taxpayer is required to register and make an election based on the applicable property for each of the 11 applicable credits. For example, for the section 45 credit, the applicable property is a qualified facility; for the section 45Q credit, it is a single process train of carbon capture equipment; and for the section 45X credit, it is a facility that produces eligible components.
• There is a 20-percent penalty imposed on an applicable entity or electing taxpayer if the amount of direct payment is excessive. This penalty does not apply if the taxpayer demonstrates that the excessive payment was due to reasonable cause. Unlike the transferability election, the proposed regulations provide no specific guidance on what constitutes reasonable cause.

Section 6418 Transferability Election

• Eligible taxpayers can elect to transfer all or any portion of an eligible credit.
  • This must be determined as a proportionate share of the full credit, including any bonus amounts. In other words, the base credit and bonus credits cannot be transferred separately.
  • An eligible taxpayer can make multiple transfer elections with respect to an eligible credit, as long as the aggregate amount does not exceed the amount of the eligible credit.
  • A partnership or S corporation may make a transfer election with respect to any eligible credit property held directly by the entity. The amount of eligible credit determined by a transferor partnership or S corporation may be limited by the section 49 at-risk rules.
• The transfer must be for cash.
  • This includes payments by cash, check, cashier's check, money order, wire transfer, ACH transfer, or other bank transfer of immediately available funds.
  • The proposed regulations provide a safe harbor timing rule—the payment will not violate the cash requirement if it is made within the period beginning on the first day of the eligible taxpayer's taxable year during which the eligible credit is determined and ending on the due date for the transfer election statement.
  • The eligible taxpayer can contract in advance for the sale of one or more years of credits, as long as the cash payments are made during the safe harbor time period.
• Treatment of credit by transferee.
  • If the transferee pays less for the eligible credit than the credit amount, there is no gross income to the transferee.
  • The transferee does not apply rules that relate to the determination of the eligible credit, such as the rules in section 49 (at-risk rules) or 50(b) (certain property not eligible for a credit), but the transferee must apply rules that relate to its own particular circumstances, such as the rules in section 38 (computation of general business credit) or 469 (passive activity limitation).
  • Any recapture tax under section 50(a), 49(b), or 45Q(f)(4) is imposed on the transferee, but there is no prohibition against a contractual indemnity by the eligible taxpayer to the transferee.
  • There is a 20-percent penalty imposed on a transferee if the credit transferred is excessive. This penalty does not apply if the transferee demonstrates that the excessive credit transfer resulted from reasonable cause. The reasonable cause determination is based on the relevant facts and circumstances, including the transferee's efforts to determine the proper amount of the credit transferred.
• Treatment of payments for the eligible credit.
  • The cash paid for the credit is not included in the eligible taxpayer's gross income nor deductible by the transferee.
  • There is an anti-abuse rule, which disallows a transfer election or otherwise recharacterizes the consequences of a transaction if the parties engage in the transaction or series of transactions with the principal purpose of avoiding tax liability beyond the intent of section 6418. For example, if an eligible taxpayer under- or over-charges for services a customer that is also purchasing credits, it may violate the anti-abuse rule.
• An eligible credit can only be transferred once.
  • An allocation of the credit to a direct or indirect owner of a transferee passthrough entity does not violate the no second transfer rule.
  • A credit cannot be transferred to a dealer or intermediary and then to a transferee taxpayer. However, a broker can match eligible taxpayers and transferees without violating the no second transfer rule, as long as the broker does not take ownership of the transferred credit.
• Time and manner of making election.
  • An election must be made for each eligible credit property for each taxable year of an eligible taxpayer.
  • The eligible taxpayer is required to register and make an election based on the appropriate unit of measurement for each of the 11 eligible credits. For example, for the section 30C credit, the registration and election are made on a property-by-property basis; for the section 45X credit, it is made on a facility-by-facility basis; and for the section 45Q credit, it is made on the basis of a single process train of carbon capture equipment.
  • An eligible taxpayer must make the transfer election on its original (and not amended) tax return, including Form 3800, General Business Credit, reporting the registration number and an attached schedule showing the amount of credit transferred for each eligible credit property.
  • There is no late election relief under Treas. Reg. §§ 301.9100-1 through 301.9100-3.
  • A transfer election statement must also be included with the tax return, which is a written document completed by the eligible taxpayer and the transferee that includes information on the transferee, the amount of credit transferred, a statement that the parties are not related, a representation that the eligible taxpayer has complied with all the requirements to make a transfer election, and a statement acknowledging the notification of recapture requirements.

Pre-Registration Requirements

• Temporary regulations provide for mandatory information and registration requirements for taxpayers planning to make a transfer election or a direct payment election (including direct payment elections under the Inflation Reduction Act energy provisions and the CHIPS Act provisions for the advanced manufacturing investment credit under section 48D).
• Under the temporary regulations, a pre-filing electronic registration is required in order to:
  • Make a direct payment election under section 6417. An applicable entity or electing taxpayer is required to use the pre-filing registration process to register itself as intending to make the direct payment election, to list all applicable credits it intends to claim, and to list each applicable credit property that contributed to the determination of such credits as part of the pre-filing submission (or an amended submission).
  • Transfer any portion of an eligible credit under section 6418.
  • Claim any advanced manufacturing investment credits under section 48D.
• Under each pre-filing registration program:
  • A separate registration is required with respect to each separate facility or credit property, but no guidance is provided to determine when facilities will be treated as separate.
  • Receipt of a registration number will not—in and of itself—guarantee that a credit will be allowed or a direct payment will be made.
  • Certain "specific information" will be required in the registration process in order to prevent duplication, fraud, improper payments, or excessive payments under section 48D.
  • Registration must be renewed on an annual basis and registrations must be updated to reflect any changes in the applicable facts.
  • Taxpayers are required to include each registration number on their annual tax return for the relevant taxable year. In addition, under the section 6418 transfer election program, a transferee taxpayer is required to report the registration number received from the eligible taxpayer that made the transfer election on its return for the taxable year that the transferee taxpayer takes the transferred eligible credit into account.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.