[co-author: Trey Frye]

On March 5, 2024, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (the “Service”) issued final regulations (the “Final Direct Pay Regulations”) regarding the direct pay election¹ for certain tax credits available under section 6417 of the Internal Revenue Code of 1986, as amended (the “Code”). Our prior coverage of the proposed regulations regarding the direct pay election can be found here.²

Simultaneously, Treasury and the Service released both proposed regulations (REG-101552-24) under Code section 761(a) that would permit entities that co-own renewable energy projects to elect out of partnership tax status if certain requirements are satisfied (the “Proposed 761 Regulations”)³ and final regulations regarding the direct pay election for the tax credit available under Code section 48D.⁴

The Final Direct Pay Regulations generally adopt the temporary and proposed regulations released in June; however, some of the more notable modifications (or lack thereof) included in the Final Direct Pay Regulations are highlighted below:

Eligibility for an Elective Payment Election

• The Final Direct Pay Regulations maintain that a partnership is generally ineligible to make an elective payment election regardless of the number of partners of such partnership that are applicable entities. However, in an unexpected turn of events, Treasury and the Service issued the Proposed 761 Regulations, which provide a viable path for applicable entities to co-own, though unincorporated organizations, certain direct pay eligible projects.⁵ The Proposed 761 Regulations would generally permit a full or partial election out of partnership treatment if four requirements are satisfied:
  • (1) the unincorporated organization must be at least partially owned by an applicable entity;
  • (2) the members of the organization must enter into a joint operating agreement with respect to the applicable credit property in which they reserve the right to take in kind or dispose of their pro rata shares of the electricity produced, extracted, or used or any associated renewable energy credit or similar credits;
  • (3) pursuant to the joint operating agreement, the organization must be organized exclusively to jointly produce electricity from its applicable credit property and with respect to which one or more of certain applicable credits is determined; and
  • (4) one or more member that is an applicable entity must make an elective payment election under Code section 6417(a) for the applicable credits determined with respect to its share of the applicable credit property.
• Consistent with the proposed direct payment regulations, applicable entities that purchase a credit under Code section 6418 may not elect direct pay for such credits (that is, “chaining”). However, the Final Direct Pay Regulations note that nothing in Code sections 6417 or 6418 explicitly prohibits chaining. While Treasury and the Service have expressed concerns regarding administrability and potential for fraud with chaining, they have requested taxpayer comments (see Notice 2024-27) as they further consider potential chaining rules.
• The Final Direct Pay Regulations provide that a non-applicable entity that is a member of a consolidated group parented by any type of applicable entity (not just one parented by an Alaska Native Corporation as contemplated by the proposed direct pay regulations) may qualify as an electing taxpayer eligible to make an elective payment election with respect to a credit determined under Code sections 45V, 45Q, or 45X based on its own corporate status.
• The Final Direct Pay Regulations provide that the applicable entity or electing taxpayer must both own the underlying applicable credit property and conduct the activities giving rise to the applicable credit or, in the case of a section 45X credit for which ownership of applicable credit property is not required, to be considered (under the section 45X regulations) the taxpayer with respect to which the section 45X credit is determined. That is, with respect to all of the applicable credits with the exception of the section 45X credit, ownership of qualified property is required.
• When credit pass through elections are made (pursuant to Code section 45Q(f)(3) or 50(d)(5)), the Final Regulations confirm that the transferee of the credit is not eligible to make a direct pay election, because the transferee is not the taxpayer with respect to which the credit is determined. However, the lessor of the property in a sale-leaseback transaction under Code section 50(d)(4) would be eligible to make a direct pay election, as the applicable credit is determined with respect to applicable credit property owned and treated as originally placed in service by the lessor.

Election on Tax Return

• Although the Final Direct Pay Regulations continue to require the direct pay election to be made on an original return (that is, the election cannot be made for the first time on an amended return, withdrawn on an amended return, or made or withdrawn by filing an administrative adjustment request), the Final Direct Pay Regulations provide that numerical errors may be corrected on an amended return or administrative adjustment request, so long as the change is to a substantive item (that is, a taxpayer may not correct a blank item or an item that is described as being “available upon request”).
• The Final Direct Pay Regulations clarify that the registration number must be included on both Form 3800 and any required source credit form(s) with respect to the applicable credit property.

“No Excess Benefit” Rule

• The Final Direct Pay Regulations clarify the application of the “no excess benefit” rule — which provides that the applicable credit amount is reduced if the sum of “restricted tax exempt amounts” and the applicable credit exceed the cost of the applicable credit property — by:
  • Providing that the determination whether a tax exempt grant is made for the specific purpose of purchasing, constructing, reconstructing, erecting or otherwise acquiring an investment-related credit property is made at the time the grant is awarded;
  • Explaining that a grant awarded after acquisition of the property is generally not a restricted tax exempt amount unless the approval of the grant was mechanical and the amount was virtually assured at the time of the application; and
  • Noting that unrestricted funds are not treated as “restricted tax exempt amounts.”

Denial of Double Benefit

• Responding to taxpayer concerns that the ordering rules would reduce the benefit of direct payment if the taxpayer could have used non-applicable general business credits to reach the Code section 38(c) limitation on credits, the Final Direct Pay Regulations change the ordering of the steps and the calculation of the “net elective payment amount” (that is, the net amount paid in cash if a direct payment election is made). Under the Final Direct Pay Regulations, the net elective payment amount is the lesser of (x) the aggregate of all applicable credits or (y) the total general business credit (including applicable credits) less the total general business credit allowed against tax liability (that is, for which a direct payment is not made), as determined under Code section 38(c).
  • These revisions ensure that taxpayers making a direct pay election will not have to delay using non-applicable general business credits because of an applicable credit.

*Trey Frye is a law clerk in our New York office.

¹ The direct pay election was enacted as part of the Inflation Reduction Act of 2022 (the “IRA”), which provided that, for taxable years beginning after December 31, 2022, “applicable entities” could elect to treat certain tax credits as a payment against U.S. federal income tax — potentially turning the applicable tax credit into a cash payment from the government.

“Applicable entities” are defined in Code section 6417(d)(1) as: (1) any organization exempt from the tax imposed by subtitle A; (2) any State or political subdivision thereof; (3) the Tennessee Valley Authority; (4) an Indian tribal government (as defined in Code section 30D(g)(9)); (5) any Alaska Native Corporation (as defined in section 3 of the Alaska Native Claims Settlement Act (43 U.S.C. 1602(m))); or (6) any corporation operating on a cooperative basis that is engaged in furnishing electric energy to persons in rural areas.

The tax credits generally include: the alternative fuel vehicle refueling property credit (Code section 30C); the production tax credit (“PTC”) (Code section 45) for facilities originally placed in service after December 31, 2022; the carbon oxide sequestration credit (Code section 45Q) for facilities originally placed in service after December 31, 2022; the zero-emission nuclear power production credit (Code section 45U); the clean hydrogen production credit (Code section 45V) for facilities originally placed in service after December 31, 2022; the qualified commercial vehicles credit (Code section 45W) for certain tax exempt entities; the advanced manufacturing production credit (Code section 45X); the investment tax credit (“ITC”) (Code section 48); the technology neutral ITC (Code section 48E) and PTC (Code section 45Y); the clean fuel production credit (Code section 45Z); and the qualifying advanced energy projects credit (Code section 48C).

While the regulations refer to “direct pay” as “elective payments,” we have continued to refer to the mechanic as “direct pay” in this alert.

² Our prior coverage of the direct pay election introduced in IRA can be found here (See “5. Credit Flexibility”) and here.

³ Comments on the Proposed 761 Regulations are due by May 10, 2024, and a public hearing will be held on May 20, 2024.

⁴ Code section 48D incentivizes the manufacture of semiconductors and semiconductor manufacturing equipment within the United States. A discussion of the final regulations for the section 48D credit under the CHIPS Act of 2022 is beyond the scope of this alert.

⁵ Credits included for this purpose are the renewable electricity production credit determined under Code section 45(a), the zero-emission nuclear power production credit determined under Code section 45U(a), the clean electricity production credit determined under Code section 45Y(a), the energy credit determined under Code section 48, and the clean electricity investment credit determined under Code section 48E.