Key Takeaways

• On March 5, 2024, Treasury and the IRS issued final regulations addressing direct pay elections for certain renewable energy credits.
• Eligible taxpayers and taxable entities seeking to make a direct pay election should pay close attention to the specific rules regarding the process for making the election and the timing for receiving proceeds from the government. The final regulations maintain that a direct pay election must be made on an original return filed no later than the due date (including extensions) for the taxable year for which the applicable credit is determined. Thus, a direct pay election may not be made on an amended return or through an administrative adjustment request. The final regulations do allow taxpayers to correct “numerical errors” in an election on an amended return if the original return and election contained all the required information. A taxpayer may not correct an item that was left blank on the original election.
• For entities that file federal returns, the deemed payment is treated as having been made on the later of the due date (determined without regard to extensions) of the return of tax for the taxable year or the date on which such return is filed with the IRS. For entities that do not file returns (e.g., governmental or political subdivisions), the elective payment is treated as having been made on the later of the date that a return would be due or the submission of a claim for credit or a refund. Taxpayers requested that payments be made earlier than these dates, such as quarterly, but the IRS and Treasury declined to adopt those suggestions. The final rules may weigh significantly in certain taxpayer decisions regarding whether to elect direct pay or instead accelerate receiving payments by transferring eligible credits under § 6418 of the Internal Revenue Code.
• The final regulations held firm that partnerships and corporations are eligible only to receive credits under §§ 45Q (carbon capture), 45V (clean hydrogen) and 45X (clean energy manufacturing) via direct pay. Thus, applicable entities (as defined below) are not eligible to receive credits through a partnership or corporation, even if all the partners or shareholders are applicable entities.
• The final regulations adopt the proposed regulations’ rules regarding “chaining,” which refers to a transferee taxpayer that acquires a credit via transfer under § 6418 and then seeks to make a direct pay election for any specified credit portions received via such transfer. As such, transferee taxpayers are not eligible to make direct pay elections on credits they acquire under § 6418.

As covered in our prior alerts, the Inflation Reduction Act[1] modified and reinstated existing renewable energy credits, enacted new renewable energy credits, and enacted under § 6417 an election that allows applicable entities to treat the amount of certain tax credits as a payment of U.S. federal income tax. This election, known as a direct pay election, allows certain applicable entities that ordinarily would not benefit from renewable energy credits to claim an equivalent amount of tax credits in the form of direct payments from the IRS, while certain taxable entities (i.e., taxpayers that qualify for renewable credits under §§ 45Q, 45V or 45X) will have another way to monetize certain renewable credits. The Treasury and IRS opened the pre-filing registration tool in December 2023 and last week published final regulations on the direct pay election. This alert expands on our prior alert discussing the direct pay proposed regulations.

General Provisions

1. Pre-Filing Registration Procedures
   • The IRS issued Publication 5884 and opened its pre-filing registration tool in December. Prior to making an election, an applicable entity must register each facility or property that gives rise to an applicable credit. The direct pay election is not effective unless the applicable entity or electing taxpayer receives a valid registration number for the applicable credit property. The pre-filing registration tool allows taxpayers to complete the registration process.
   • The pre-filing registration process requires an applicable entity or eligible taxpayer to provide the entity’s tax information (i.e., legal entity type, legal name, taxable year, Employer Identification Number, etc.), the type of applicable credit and information regarding the applicable credit property.
   • Publication 5884 recommends taxpayers complete the pre-filing registration process at least 120 days prior to the date the taxpayer will file their federal tax return containing a direct pay election.
2. Eligible Credits
   • The § 6417 elective payment elections apply to the following 12 credits: the alternative fuel vehicle refueling property credit, under § 30C; the renewable electricity production credit, determined under § 45(a); the carbon oxide sequestration credit, determined under § 45Q(a); the zero-emission nuclear power production credit, determined under § 45U(a); the production of clean hydrogen credit, determined under § 45V(a); in the case of a “tax-exempt entity” described in §§ 168(h)(2)(A)(i), (ii) or (iv), the qualified commercial vehicles credit, as determined under § 45W; the advanced manufacturing production credit, under § 45X(a); the clean electricity production credit, determined under § 45Y(a); the clean fuel production credit, determined under § 45Z(a); the investment tax credit, under § 48; the qualifying advanced energy project credit, determined under § 48C; and the clean electricity investment credit, determined under § 48E.
3. Timing of Elective Payments
   • The final regulations do not alter the timing for when taxpayers will receive direct payments. Instead, they provide that an elective payment is deemed to have been made on the later of the due date or filing date of an applicable tax return. In addition, the final regulations confirm that elective payments will not be accelerated or made available prior to the due date or filing date of a return. As a result, applicable credits are not treated as estimated tax payments and do not waive estimated tax penalties. This is expected to have a significant impact on whether certain taxable entities decide to elect direct pay or instead accelerate receiving payments by transferring eligible credits under § 6418.
4. Election
   • An elective payment election may only be made on an original return filed no later than the due date (including extensions) for the taxable year for which the applicable credit is determined. The final regulations provide that a numerical error may be corrected on an amended return or an administrative adjustment, but only if the error being corrected was not blank on the original return. The preamble notes that this is intended to address situations in which a taxpayer intended to make a direct pay election but made a reporting error with respect to an element of the election (e.g., miscalculating the amount of the credit on the original return or making a typographical error in the process of inputting a registration number). The final regulations also provide some relief to taxpayers that fail to timely file by granting an automatic six-month extension to make the election under Treasury Regulation § 301.9100-2.
   • An elective payment election is generally irrevocable and applies with respect to any applicable credit for the taxable year for which the election is made. For certain credits, the election applies for a period of years.

Tax-Exempt Entities

1. Applicable Entities
   • Tax-exempt organizations, state or local governments, Indian tribal governments, Alaska Native Regional Corporations, the Tennessee Valley Authority and rural electric cooperatives may make an election for direct pay.
   • The final regulations clarify that the term “any organization exempt from the tax” includes all organizations exempt from taxation under § 501 through § 530. Entities that qualify as nonprofits under state law but do not have federal tax-exempt status are not covered and thus may not make direct pay elections.
   • Agencies and instrumentalities of any state, the District of Columbia, Indian tribal governments, U.S. territories and political subdivisions thereof qualify as applicable entities.
   • The final regulations expand upon the definition of “state or local governments” to clarify that an entity is an agency, instrumentality or political subdivision thereof based on general federal tax law principles. Under case law, a six-factor test applies to determine whether an entity is an instrumentality. With respect to political subdivisions, the final regulations reference IRS guidance defining a political subdivision as either (1) a division of a state or local government that is a municipal corporation or (2) a division of such state or local government that has been delegated the right to exercise sovereign power (i.e., the power to tax, the power of eminent domain and police power) by the state or local government. Finally, the final regulations state an entity is a division of a state under IRS guidance if it is controlled by the state or local government and motivated by a wholly public purpose. Commentators were hoping for more guidance that listed what entities would qualify, but, unfortunately, the final regulations defer to general tax principles for these determinations.
   • Other than for §§ 45Q, 45V and 45X credits, partnerships and S corporations may not make direct pay elections. Thus, applicable entities desiring to pool their resources in order to invest in a renewable energy project would need to do so in a legal form other than a partnership. The final regulations provide as examples a co-ownership arrangement treated as a tenancy-in-common and joint operating agreements that elect out of the partnership tax rules.
   • Notwithstanding that an applicable entity may not hold an applicable credit property through a partnership, it may do so through a disregarded entity.
   • Public-private partnerships are not considered applicable entities because they are partnerships for federal income tax purposes. As such, they are not eligible to make direct pay elections.
2. Determination of Credit
   • Any property of an applicable entity with respect to which an eligible credit is determined is considered to be used in a trade or business. This clarification allows tax-exempt and government entities to take advantage of credits outside the unrelated business taxable income context by allowing the entity to treat an item of property as if it is of a character subject to an allowance of depreciation. The rule does not, however, create any presumption that the trade or business is related or unrelated to a tax-exempt entity’s exempt purpose.
3. Grants and Forgivable Loans
   • The final regulations maintain that proceeds from nonspecific grants and forgivable loans that are exempt from federal income tax and are used to purchase, construct, reconstruct, erect or otherwise acquire an investment credit property are included in the basis of such property for purposes of computing the applicable credit amount. The final regulations confirm though that grants and forgivable loans that have a specific purpose or limit the funds from the grant or loan to the construction of eligible property require a reduction in basis. This determination is made at the time the grant or loan is extended.

For-Profit Entities

1. Entities That Are Not Applicable Entities
   • Entities that are not applicable entities may make a direct pay election for credits under §§ 45Q, 45V or 45X. The election is available for the first five years of the credit period, after which the credits again become nonrefundable for those taxpayers. The final regulations contain specific rules about entities that have made a direct pay election and experience an ownership change. In general, the final regulations provide that the election continues after the change in ownership and that the credit period does not restart.
2. Partnerships and S Corporations
   • Partnerships and S corporations are eligible to receive credits under §§ 45Q, 45V and 45X via direct pay. The election must be made by the partnership or S corporation and direct payments are made to the partnership or S corporation. The applicable credit amount is treated as tax-exempt income, and a partner’s distributive share is based on the partner’s distributive share of the otherwise applicable credit for each taxable year. The final regulations confirm that the income is not treated as passive for the purposes of § 469.
3. Direct Pay for Transferee Taxpayers
   • The final regulations maintain that a transferee taxpayer that acquires a credit via transfer under § 6418 cannot make a direct payment election for any specified credit portions received via such transfer. The regulations refer to this as “chaining” and no exceptions are made even for taxpayers that, while not producers, are involved with the manufacturing or purchase of property giving rise to the credit. The IRS has requested additional comments on the issue in Notice 2024-27.

[1] P.L. 117-169.

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