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Regulations finalized on direct payment of tax credits
April 2024
In brief
What happened?
The IRS and Treasury on March 11 published final regulations on direct payment under Section 6417 of certain energy credits and under Section 48D of the advanced manufacturing credit. Proposed regulations were published on June 21, 2023. The IRS and Treasury also published proposed regulations (2024 proposed regulations) addressing how tax-exempt entities participating in energy projects under a co-ownership structure may qualify to elect Section 6417 direct payment of certain credits.
The Section 6417 and Section 48D final regulations apply to tax years ending on or after March 11, 2024. However, taxpayers generally may apply the final regulations to property placed in service after 2022 if they apply the entire regulations consistently. The 2024 proposed regulations would apply to tax years ending on or after publication of final regulations in the Federal Register. Comments are due by May 10, 2024, and a public hearing is scheduled for May 20, 2024.
The IRS and Treasury also released Notice 2024-27, which requests comments on allowing a recipient of a transferred credit to elect direct payment.
Why is it relevant?
Direct payments are an important mechanism to fund energy and advanced manufacturing projects by allowing taxpayers with little or no tax liability to receive the economic benefit of the credit. The final regulations provide certainty in many areas and make a taxpayer-favorable change to the rules for computing the net elective payment amount. The 2024 proposed regulations facilitate current financing practices by providing a path for certain partnerships to elect direct payment for additional credits.
Action to consider:
Tax-exempt entities that engage in an energy project within a co-ownership structure should consider whether it would be beneficial to opt out of subchapter K under Section 761(a) for that project under the 2024 proposed regulations and elect direct payments.
For detailed information on direct payments and the proposed regulations under Sections 6417 and 48D, see the PwC Insights Regulations address direct payment of energy tax credits and Regulations address direct payment of advanced manufacturing tax credit.
In detail
Statutory background
For tax years beginning before 2033, Section 6417 allows an applicable entity to irrevocably elect to treat a credit under Section 30C, 45, 45Q, 45U, 45V, 45W, 45X, 45Y, 45Z, 48, 48C, or 48E (applicable credits) as a payment against tax in the amount of the credit. An applicable entity is a tax-exempt entity, state or political subdivision, the Tennessee Valley Authority, Indian tribal government, Alaska native corporation, or rural electric cooperative.
Other taxpayers may elect direct payment only for the Section 45Q, 45V, or 45X credits. A direct payment election must be made by a partnership or S corporation for property held by the entity.
The direct payment election is made on a federal income tax return by the extended due date and is reflected on the return as a “payment,” which reduces the tax due. Thus, the credit is available without regard to tax liability, similar to a refundable credit. To prevent receipt of a double benefit, the amount of the credit is reduced to zero and deemed to have been allowed in the tax year of the direct payment.
Section 48D provides a credit of 25% of qualified investment in a facility that manufactures semiconductors or the equipment to manufacture semiconductors. Section 48D includes provisions for any taxpayer eligible to claim the credit to elect direct payment under substantially the same requirements and procedures as under Section 6417.
Regulatory provisions specific to Section 6417 direct payments
Definition of applicable entities
The Section 6417 final regulations clarify that “applicable entities” include territories, the District of Columbia, and government agencies and instrumentalities.
Applicable entities participating in partnerships
The Section 6417 proposed and final regulations provide that a partnership is not an applicable entity, even if all partners are applicable entities, and may elect direct payment only for the Section 45Q, 45V, or 45X credits. As a result, applicable entities engaged in an energy project as a partner in a partnership may receive direct payments (if elected by the partnership) only for credits under Sections 45Q, 45V, and 45X. However, the proposed and final regulations provide that an applicable entity that participates in an energy project through an organization that opts out of subchapter K under Section 761(a) is treated as directly owning its interest in the credit property and may elect direct payment for any applicable credit.
Section 761(a) allows an unincorporated organization to elect to be excluded from the application of subchapter K if (1) the organization is for investment purposes only and not for the conduct of a business, (2) the organization is for the joint production, extraction, or use of property and not to sell services or the property produced or extracted (or for certain activities of securities dealers), and (3) the income of the organization members can be adequately determined without computing partnership taxable income.
Current regulations under Section 761(a) require that participants in the joint activity (1) co-own the property directly rather than through an interest in an entity that owns the property (co-ownership requirement), (2) have the right under the agreement to separately take or dispose of their shares of property acquired or retained (severance requirement), and (3) do not jointly sell services or the property produced or extracted (joint marketing requirement) but allow a participant to delegate authority to sell its property for a period not exceeding the minimum needs of the industry or one year.
The preamble to the 2024 proposed regulations explains that the co-ownership and severance requirements in the current Section 761 regulations are inconsistent with established industry practices for structuring renewable energy projects. Accordingly, the 2024 proposed regulations would amend the Section 761(a) regulations for Section 6417 purposes to provide special exceptions to the co-ownership and severance requirements for applicable entities. The exceptions would apply to an “applicable unincorporated organization,” which would be owned in whole or in part by one or more applicable entities that enter into a joint agreement to produce electricity from credit property eligible for the Section 45, 45U, 45Y, 48, or 48E credit. The agreement would have to provide members the right to separately receive or dispose of their pro rata shares of the electricity produced or of any associated renewable energy or similar credits, and at least one member would have to plan to elect direct payment. If these conditions are met, applicable entities could own credit property through an unincorporated entity (if the entity is not required to be treated as a corporation) and, under the rule in the final regulations, would be treated as directly owning its interest in the credit property and be eligible to elect direct payments for a Section 45, 45U, 45Y, 48, or 48E credit related to the property.
The 2024 proposed regulations also amend the Section 761 regulations to allow a member to authorize a delegee to enter into contracts to sell the electricity produced that extend beyond the minimum needs of the industry and for more than one year. However, the length of the delegation continues to be limited by the minimum needs of the industry and one year.
Direct payment elections after credit transfers
Section 6418 allows taxpayers to transfer a Section 30C, 45, 45Q, 45U, 45V, 45X, 45Y, 45Z, 48, 48C, or 48E credit to other parties, which then claim the credit. The Section 6417 proposed and final regulations do not permit a credit transferee to elect direct payment for the transferred credit. The preamble to the final regulations advises that allowing this process, which it calls “chaining,” is a less reasonable interpretation of Sections 6417 and 6418 and could result in administrative complexity and have a potential for abuse.
However, contemporaneously with the release of the final regulations on March 5, the IRS and Treasury issued Notice 2024-27, requesting additional comments on permitting chaining, specifically with regard to impact on the credit transfer market, statutory interpretation, administrability, and potential for abuse. Comments are due by December 1, 2024.
Regulatory provisions specific to Section 48D direct payments
Partner’s distributive share of direct payments
Section 48D provides that a partner's distributive share of a direct payment is based on the partner's distributive share of the otherwise applicable credit for the tax year. As an investment credit, the Section 48D credit, in general, is a percentage of the basis of qualified property. Accordingly, the Section 48D proposed and final regulations provide that a partner’s distributive share of a direct payment is equal to the partner’s distributive share of its allocable basis in the Section 48D qualified property.
The preamble to the proposed regulations noted that some taxpayers may have entered into partnership agreements before issuance of proposed regulations and incorrectly assumed that the partners’ distributive shares of direct payments would be allocated based on income allocation rules instead of rules relating to allocations of investment credits. Therefore, the final regulations include a transition rule allowing a partner’s distributive share of a direct payment to be determined in accordance with partnership income allocation principles if a written binding partnership agreement was entered into after 2021 and before June 22, 2023, and the partnership was formed to own and operate an advanced manufacturing facility or qualified property.
Observation: This issue does not arise for applicable credits under Section 6417 because partnerships may not elect direct payment under Section 6417 for investment tax credits.
Regulatory provisions applicable to both Section 6417 and Section 48D direct payments
Direct payment computation
The Section 6417 applicable credits and the Section 48D credit are included in the Section 38 general business credit (GBC). The GBC may be limited by tentative minimum tax and carried back or carried forward to other tax years. Section 38 includes rules that specify the order in which the constituent credits are taken into account. The Section 6417 and Section 48D proposed regulations include credits for which direct payment was elected in computing the GBC and determining the amount subject to limitations. The proposed regulations provided a five-step process for both applicable entities and electing taxpayers to determine a “net elective payment amount” that included the direct payment in the Section 38 limitations and ordering rules.
The final regulations revise the five-step process. Under the final regulations, the net elective payment amount Is the lesser of (1) the aggregate of all Section 6417 applicable credits (or the Section 48D credit) or (2) the total GBC (including applicable credits/the Section 48D credit) over the total GBC allowed against tax liability determined without regard to Section 38(c) (the limitations).
Observation: Under the proposed computation rule, a direct payment amount was included in determining the amount of the Section 38 GBC allowable in the current tax year and the amount that would have to be carried to other tax years. Depending on what other Section 38 credits a taxpayer could claim and where the direct payment stood in the credit order, the taxpayer could be disadvantaged or even denied the benefit of a direct payment. By revising the five-step computation, the final regulations take the direct payment out of the GBC limitation. The preambles of the two final regulations explain that the revised rules allow a taxpayer to lower tax liability to the GBC limitation using other credits without impact from the Section 6417/Section 48D credits but include these credits as a current year GBC to the extent necessary to reduce tax liability to the GBC limitation.
Time for election
The Section 6417 and Section 48D proposed regulations required a direct payment election to be made on an original federal income tax return by the extended due date. An election could not be made on an amended return and late filing relief under Reg. 301.9100-1 was not available. The final regulations permit taxpayers to correct numerical errors, for example in the amount of the credit, on an amended return or administrative adjustment. The final regulations provide six months late filing relief for taxpayers that fail to make the direct payment election on their returns, but only for taxpayers that file their returns by the unextended due date.
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