On June 14, 2023, the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued guidance on several topics related to tax credit monetization under the Inflation Reduction Act of 2022 (IRA), including proposed regulations related to elective payment and transferability, proposed regulations concerning the elective payment election of the advanced manufacturing investment credit under the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act of 2022, and temporary regulations setting forth mandatory information and registration requirements for taxpayers planning to make a transferability or elective payment election under the IRA and CHIPS Act.

This legal alert discusses Proposed Regulations regarding elections to treat an applicable credit as a payment against tax for the taxable year that the credit was determined (elective payment) under section 6417 of the Internal Revenue Code of 1986, as amended (Code). We previously issued a legal alert providing an overview of all of the guidance with our preliminary observations, along with an in-depth legal alert on the new transferability regime. Future alerts with our analysis of the other pieces of guidance are forthcoming.

The Proposed Regulations describe rules for the election to treat the elective payment amount of applicable tax credits in a taxable year as a payment of federal income tax, include definitions and special rules applicable to partnerships and S corporations, provide rules related to excessive payment or recapture events and outline the required pre-filing registration process. They include commentary requested in Notice 2022-50, on potential issues related to elective payment.

Key Takeaways

The Proposed Regulations provide long-awaited guidance on the elective payment regime and may lead to an increase in the market for energy tax credits going forward. Key takeaways from the Proposed Regulations include:

• An applicable entity or electing taxpayer under section 6417 that is the transferee of any specified credit under section 6418, 45Q(f)(3), and certain leases would be ineligible for elective payment under section 6417 with respect to any amount of such transferred credits.
• Because applicable entity status is limited to certain tax-exempt, government, and similar categories of entities, and is determined at the entity level, partnerships and S corporations do not qualify as applicable entities. This is true even if the partners or S corporation shareholders could, themselves, qualify as applicable entities.
• Electing taxpayers that are otherwise not applicable entities, including partnerships and S corporations, may elect to be treated as applicable entities eligible for elective payment with respect to certain credits – i.e., sections 45V, 45Q and 45X credits.
• Once made, the election for elective payment of an applicable credit is irrevocable. However, the election to be treated as an applicable entity for purposes of the sections 45V, 45Q, and 45X credits can be revoked once.
• Taxpayers seeking to take advantage of direct payment under section 6417 must pre-register with the IRS.

Procedural Matters

Taxpayers may rely on the Proposed Regulations for taxable years beginning after December 31, 2022, and before final regulations are published in the Federal Register, provided the Proposed Regulations are followed in their entirety and in a consistent manner with respect to all elections made under section 6417.

Written comments on the Proposed Regulations should be submitted by August 14, 2023 and requests to speak with discussion outlines are due on or before August 14, 2023. A public hearing will be held on August 21, 2023.

Background – Section 6417

Section 6417 provides a new elective payment regime that enables certain specified taxpayers to treat the amount of certain energy tax credits as payments of federal income tax for the taxable year with respect to which such credit was determined. The new elective payment regime is commonly understood to be a means for monetizing such tax credits. Under section 6417, “applicable entities” (as defined by the Proposed Regulations) may elect to treat the amount of certain “applicable credits” as payments of income tax. Applicable credits include:

• So much of the credit for alternative fuel vehicle refueling property allowed under section 30C which, pursuant to section 30C(d)(1) is treated as a credit listed in section 38(b);
• Renewable electricity production credits (section 45) (as is attributable to qualified facilities which are originally placed in service after December 31, 2022);
• Credits for carbon oxide sequestration (section 45Q) (as is attributable to carbon capture equipment which is originally placed in service after December 31, 2022);
• Zero-emission nuclear power production credits (section 45U(a));
• Clean hydrogen production credits (section 45V(a)) (as is attributable to qualified clean hydrogen production facilities which are originally placed in service after December 31, 2012);
• Qualified commercial vehicle credits (section 45W(a)) (for tax-exempt entities including the United States, any State thereof, any foreign person or entity, and any Indian tribal government);
• Advanced manufacturing production credits (section 45X(a));
• Clean electricity production credits (section 45Y(a));
• Clean fuel production credits (section 45Z(a));
• Energy credits (investment tax credits) (section 48);
• Qualifying advanced energy project credits (section 48C); and
• Clean electricity investment credits (section 48E).

Under the Proposed Regulations an “applicable entity” generally refers to a tax-exempt organization, government, or other qualified entity, with the common characteristic of low to no federal income tax applying to such entities. Under the preamble to the Proposed Regulations the rationale for the elective payment regime provides that “[a]llowing entities without sufficient federal income tax liability to use a business tax credit to instead make an election to receive a refund of any overpayment of taxes created by the elective payment election will increase the incentive for taxpayers to invest in clean energy projects that generate eligible credits because it will increase the amount of cash available to those entities, thereby reducing the amount of financing needed for clean energy projects."

Importantly, an exception in the Proposed Regulations allows for a refund of any overpayment of taxes created by the elective payment regime for sections 45V, 45Q, and 45X credits via elective payment for certain taxpayers that are not otherwise applicable entities, including in particular partnerships and S-corporations (electing taxpayers). Under this special rule, electing taxpayers may elect to be treated as an applicable entity for purposes of section 6417 for up to five years with respect to an applicable credit property.

An applicable entity or electing taxpayer must elect direct payment on the due date (including extensions of time) for the tax return for which the election is made. In the case of any government or political subdivision that is not required to file tax returns under section 6011 or 6033(a), the elective payment election must be made no later than the due date (including an extension of time) for the original return that would be due under section 6033(a) if such applicable entity were described in that section. The preamble to the Proposed Regulations provides that, subject to any guidance that is issued, an automatic paperless six-month extension from the original due date is deemed to be allowed for an entity not required to file federal tax returns under section 6011 or 6033(a).

Any elective payment election, once made, is irrevocable and shall apply with respect to any credit for the taxable year for which the election is made.

The Proposed Regulations also provide further clarification on additional special rules applicable to the elective payment regime, including:

• Authorization for Treasury to impose pre-filing registration requirements for purposes of preventing duplication, fraud, improper payments, or excessive payments.
• In the event of an excessive payment, a tax is imposed on the entity based on the sum of the excessive payment plus 20 percent. Relief from the penalty is available if the taxpayer shows reasonable cause.
• Basis reduction and recapture rules.

Proposed Rules and Definitions Related to the Elective Payment of Eligible Credits

The Proposed Regulations provide generally that an “applicable entity” may elect to treat an “applicable credit” determined with respect to any “eligible credit property” of such applicable taxpayer for any taxable year as a payment against income tax by such taxpayer. The Proposed Regulations then define several key terms used in the statute and regulations, including:

“Applicable Entity” – is (1) an entity that is exempt from income tax, (2) any State or political subdivision thereof, (3) the Tennessee Valley Authority, (4) an Indian tribal government, (5) any Alaska Native Corporation, or (6) any corporation operating on a cooperative basis that is engaged in furnishing electricity to persons in rural areas.

“Applicable Credit” – includes renewable energy credits identified in section 6417(b) (see list above). The Proposed Regulations clarify that the entire amount of any “applicable credit” is separately determined with respect to each single eligible credit property of the eligible taxpayer and includes any bonus credit amounts determined with respect to that single eligible credit property.

“Annual Tax Return” – is (1) for any taxpayer normally required to file an annual tax return with the IRS, such annual return (including Forms 1065 and 990-T), or (2) for any taxpayer that is not normally required to file an annual tax return with the IRS, the return they would be required to file if they were located in the United States, or, if no such tax return is required (as for State, District of Columbia, local, or Indian tribal government entities), the Form 990-T; and (3) for short tax year filers, the short year tax return.

“Electing Taxpayers” – any taxpayer that is not an applicable entity, but makes an election to be treated as an applicable entity for the taxable year with respect to applicable credits. A “taxpayer” is any person subject to internal revenue tax, including income taxes, employment taxes, and excise taxes. Note that electing taxpayers may only elect for elective payment on credits 45V, 45Q, and 45X.

Proposed Regulations Related to Making an Election for Elective Payment

Manner and Due Date of Making an Elective Payment Election – Although section 6417 generally allows an applicable entity elective payment of an applicable credit, the Proposed Regulations require filing Form 3800 with the tax return along with any applicable calculations required by the instructions with respect to the applicable credit property. In other words, an applicable entity that determines applicable credits with respect to two eligible credit properties would need to make a separate elective payment election, and file separate Forms 3800 for each property. The Proposed Regulations also provide that an election would be required for each taxable year an eligible taxpayer claims elective payment with respect to an eligible credit property, subject to the discussion below regarding electing taxpayers.

Election Limitations – the Proposed Regulations include certain limitations on making an election under section 6417:

• Once made, a direct payment election is irrevocable, although a taxpayer electing to be treated as an applicable entity for purposes of Sections 45V, 45Q, and 45X may revoke its election once, as explained below.

• An applicable entity or electing taxpayer that is the transferee of any specified credit portion may not make an election for elective payment under section 6417 with respect to any amount of such transferred credit. The Proposed Regulations take the position that the transferred credit is not an “applicable credit” because the credit is not determined with respect to the underlying applicable credit property owned by the applicable entity or electing taxpayer, or, if ownership is not required, activities otherwise conducted by the applicable entity or electing taxpayer. The Proposed Regulations expressly request comments regarding exceptions to the proposed rule.
• The Proposed Regulations would apply the same rule to credits transferred to the sequester of carbon oxide under Section 45Q(f)(3) and to credits transferred to a lessee.

Electing Taxpayers – Eligible taxpayers that make the election for elective payment for the 45V, 45Q, and 45X applicable credits may only apply the election for the taxable year the election is made and the four subsequent taxable years that end before January 1, 2033. Of note, electing taxpayers make the election for one five-year period per applicable credit property, which negates the need to make an elective payment election each year for such credit property. However, electing taxpayers are allowed one revocation per applicable credit property in a year subsequent to the original election period. Any such revocation applies to the taxable year in which the election to revoke was made (but not any prior taxable year) and applies to each subsequent taxable year within the original election period. An election to revoke cannot itself be revoked. A taxpayer that revokes an election to be treated as an applicable entity eligible for elective payment can transfer credits under Section 6418 to which the revocation applies (and subsequent years).

Proposed Regulations Related to Partnerships/S Corporations

The Proposed Regulations provide that an entity’s status as an applicable entity is made at the entity level, and partnerships and S corporations do not qualify as applicable entities, and any election for elective payment by a partnership or S corporation must be made as an electing taxpayer. Therefore, the only applicable credits that a partnership or S corporation may claim are the sections 45V, 45Q, and 45X credits. In general, an elective payment election is made at the entity level and no election by any partner or shareholder is allowed.

Payments to Partnership and S Corporations – For partnerships and S Corporations that elect to be treated as applicable entities for purposes of claiming direct payment of section 45V, 45Q, and 45X credits, the IRS will make a payment to the partnership or S corporation equal to the amount of the credit.

Allocations of Elective Payments – Upon receiving an elective payment from the IRS for an applicable credit, the partnership or S corporation reduces the credit amount to zero before determining any partner’s pro rata or distributive share. The credit is deemed to have been allowed solely to such entity for the taxable year, and the amount received as an elective payment is treated as tax-exempt income for purposes of sections 705 and 1366. A partner’s distributive share of such tax-exempt income is equal to such partner’s distributive share of the otherwise applicable credit for each taxable year. The tax-exempt income would be taken into account by the partnership or S corporation at the same time as the underlying credit would have been taken into account absent an elective payment election. The tax-exempt income resulting from the elective payment is treated as arising from an investment activity and not from a trade or business within the meaning of section 469(c)(1)(A). Therefore, the income would not be treated as passive income to any partners or shareholders who do not materially participate within the meaning of section 469(c)(1)(B).

The amount of the elective payment to a partnership or S corporation equals the amount of the credit that would otherwise be allowable as if the elective payment was not made. The amount of credit determined with respect to an applicable credit property held directly by the partnership or S corporation is not subject to limitation by section 469, as section 469 does not apply at the partnership level. Because applicable credits for partnerships and S corporations are not investment tax credits under section 46, sections 49 and 50 do not apply to limit the amount of credits.

Partnerships subject to BBA Audits – For the IRS to implement section 6417 and to administer the BBA centralized audit procedures at the partnership level, the IRS proposes updates to the regulations under part 301:

• Partnership-related items may include elective payments under section 6417, as the credit amount is relevant in determining the chapter 1 tax liability of the partnership in the event of an excessive payment. Further, the applicable credit is reduced by the amount of elective payment received, which would impact the amount of credits and tax-exempt income that the partners would be allocated and the partners’ chapter 1 liability.

• The Proposed Regulations include a special enforcement rule that would allow the IRS to make an adjustment regarding elective payment outside of the BBA audit rules. Under the proposed rule, the BBA centralized partnership regime would not apply to adjustments for partnership-related items that affect the amount or existence of a payment to a BBA partnership, or credit or refund of a payment made to the BBA partnership under section 6417.

Registration under 6417(d)

Pursuant to Congress’ grant of authority in section 6417(d), Treasury and IRS created registration requirements for elective payment. The pre-registration requirements identified in the Proposed Regulations are as follows:

• An applicable entity or electing taxpayer must complete the pre-filing registration process electronically through an electronic portal, which the IRS aims to launch before the end of 2023.
• An applicable entity or electing taxpayer must satisfy the registration requirements and receive a registration number prior to making an elective payment election on its return for the taxable year at issue.
• An applicable entity or electing taxpayer is required to obtain a registration number for each eligible credit property with respect to which it makes an elective payment election.
• An applicable entity or electing taxpayer must provide the following information as part of the pre-filing registration process:

• The applicable entity or electing taxpayer’s general information, including its name, address, taxpayer identification number, and type of legal entity;
• Any additional information required by the IRS electronic portal, such as information establishing that the entity is an applicable entity or electing taxpayer;
• The applicable entity or electing taxpayer’s taxable year;
• The type of annual tax return(s) normally filed by the applicable entity or electing taxpayer, or that the entity does not normally file an annual tax return with the IRS;
• The type of eligible credit(s) for which the eligible taxpayer intends to make an elective payment election;
• Each eligible credit property that the applicable entity or electing taxpayer intends to use to determine a specified credit portion for which the entity intends to make an elective payment election, and, for each such property, any further information required by the IRS electronic portal, including:
  • The type of eligible credit property;
  • Physical location (address and coordinates (longitude and latitude) of the eligible credit property);
  • Any supporting documentation relating to the construction or acquisition of the eligible credit property;
  • The beginning of construction date, and the placed in service date of the eligible credit property; and
  • Any other information that the eligible taxpayer believes will help the IRS evaluate the registration request;
• The name of a contact person for the eligible taxpayer; and
• Any other information the IRS deems necessary for purposes of preventing duplication, fraud, improper payments, or excessive payments under this section that is provided in guidance, including whether an investment tax credit property was acquired using any “Restricted Tax Exempt Amounts” (as defined by the Proposed Regulations).

Special Rules

Excessive Payment – The Proposed Regulations provide special rules relating to the determination of an “excessive payment,” as well as reasonable cause for an applicable taxpayer.

As a general matter, where Treasury or the IRS has identified an excessive payment, section 6417 imposes an additional tax on the applicable entity (regardless of whether the applicable entity would have been subject to tax) equal to the sum of (i) the amount of such excessive payment, plus (ii) 20 percent of such excessive payment. The 20 percent penalty will not be imposed if the applicable entity satisfies the IRS that the excessive payment resulted from reasonable cause.

The Proposed Regulations define “excessive payment” to mean, with respect to an eligible credit property, an amount equal to the excess of: (i) the amount treated as a payment with respect to such eligible credit property or facility for such taxable year; over (ii) the amount of the eligible credit that, without the application of section 6417, would be otherwise allowable under the Code with respect to such eligible credit property for such taxable year. Examples of excessive payments provided in the Proposed Regulations include improperly claimed bonus amounts of credit, inflated basis, failure to apply 38(d) ordering rules, or misapplication of the credit utilization rules. The excessive payment tax is imposed on the applicable entity in the year the determination is made, even if it is a later year than the year in which the credit was allowable.

The identification of an excessive payment is a facts-and-circumstances determination, and the determination of reasonable cause includes an evaluation of an applicable entity or electing taxpayer’s efforts to determine the amount of the applicable credit. Treasury and the IRS anticipate that the existing standards of reasonable cause will inform the determination by the IRS of whether reasonable cause has been demonstrated.

Basis Reduction and Recapture – Section 6417 includes a recapture mechanism that follows section 50 of the Code. Under section 50, recapture of a tax credit occurs when the original tax credit reported would have been correct without the occurrence of a subsequent recapture event, such as a sale or disposal of the eligible property. Applicable entities that do not typically file a tax return nevertheless must file an annual tax return for the year of recapture, in the manner prescribed by the IRS in future guidance, along with supplemental forms such as Form 4255, Recapture of Investment Credit. As noted above, the recapture rules operate separately from the excessive payment rules. The Proposed Regulations also emphasize that the basis reduction and recapture rules of section 50 only apply to investment tax credits.

Conclusion

The Proposed Regulations provide much-needed guidance and clarification on the new elective payment regime, answering a number of questions commonly posed regarding these rules, although not always in a way favorable to eligible taxpayers. We expect to continue to see increased activity with elective payment of renewable energy credits now that Treasury and IRS have set forth this guidance.

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