Key Takeaways

• The IRS and U.S. Treasury Department issued on June 14, 2023, proposed and temporary regulations addressing direct pay elections for certain renewable energy credits.
• The proposed and temporary regulations provide guidance on the pre-filing registration requirements and how to make a direct pay election.
• Taxpayers that want to comment on the proposed regulations have until August 14, 2023, to submit comments to the IRS and U.S. Treasury Department.

Overview

As covered in our prior alerts, the Inflation Reduction Act[1] (IRA) modified and reinstated existing renewable energy credits, enacted new renewable energy credits, and enacted under § 6417 an election that allows applicable taxpayers 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 non-taxable entities (as defined below) 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 Internal Revenue Service (IRS), while certain taxable entities (i.e., taxpayers that qualify for renewable credits under § 45Q, § 45V, § 45X) will have another way to monetize certain renewable credits.

Takeaways from the proposed and temporary regulations include the following:

• The proposed and temporary regulations provide guidance on the pre-filing registration process that, once completed, will allow applicable taxpayers to make direct pay elections.
• Those regulations also provide applicable taxpayers with guidance regarding how to make direct pay elections. For taxpayers that file an annual return, the election may only be made on an original return filed no later than the due date (including extensions) for the original return for the taxable year for which the applicable credit is determined.
• For entities that file federal returns, the election payment is treated as 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 (i.e., governmental or political subdivisions), the elective payment is treated as made on the later of the date that a return would be due or the submission of a claim for credit or refund.
• The proposed regulations confirm that the term “any organization exempt from the tax” includes all organizations exempt from tax under § 501(a). The proposed regulations further confirm that agencies and instrumentalities of any state or the District of Columbia, Indian tribal governments, U.S. territory, or political subdivision thereof qualify as applicable entities.
• Partnerships and S corporations are only eligible to receive credits under § 45Q, § 45V and § 45X via direct pay. Thus, applicable taxpayers are not eligible to receive credits through a partnership.
• The proposed regulations provide 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.

Below is a summary of the key aspects of the proposed and temporary regulations.

General Provisions

1. Eligible Credits

• The § 6417 elective payment elections apply to the following 12 credits: alternative fuel vehicle refueling property under § 30C; renewable electricity production credit determined under § 45(a); carbon oxide sequestration determined under § 45Q(a); zero-emission nuclear power production credit determined under § 45U(a); production of clean hydrogen determined under § 45V(a); in the case of a “tax-exempt entity” described in § 168(h)(2)(A)(i), (ii) or (iv), the credit for qualified commercial vehicles determined under § 45W; advanced manufacturing production credit under § 45X(a); clean electricity production credit determined under § 45Y(a); clean fuel production credit determined under § 45Z(a); investment tax credit under § 48; qualifying advanced energy project credit determined under § 48C; and clean electricity investment credit determined under § 48E. An applicable entity that makes a direct pay election is treated as making a payment against U.S. federal income taxes for the taxable year with respect to which such credit was determined equal to the amount of such credit. If the amount of the payment exceeds the taxes owed, the applicable entity would receive a refund.
• The amount of an applicable credit includes any eligible bonus credit amounts (e.g., increases to credits for meeting the wage and apprenticeship requirement or domestic content bonus credit requirements).

2. At-Risk and Passive Activity Rules

• Certain at-risk rules under § 49 and passive activity rules under § 469 apply with respect to the determination of applicable credits under § 6417.

3. Election

• The proposed regulations provide that an applicable entity or electing taxpayer makes an elective payment election on their annual tax return as prescribed by IRS guidance. The applicable entity or electing taxpayer must also include any required IRS forms relating to the applicable credit property and a completed IRS Form 3800.
• 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.
• An elective payment election may only be made on an original return filed no later than the due date (including extensions) for the original return for the taxable year for which the applicable credit is determined. No elective payment election may be made or revised on an amended return or by filing an administrative adjustment request.
• The election must be made for each facility or property related to the eligible credits.

4. Pre-Filing Registration Requirements

• 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 process requires an applicable entity or eligible taxpayer to provide the entity’s tax information (i.e., legal entity type, legal name, taxable year, EIN, etc.), the type of applicable credit, and information regarding the applicable credit property.

5. Timing of Payments

• For entities that file federal returns, the election payment is treated as 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 (i.e., governmental or political subdivisions), the elective payment is treated as made on the later of the date that a return would be due or the submission of a claim for credit or refund.

Tax-Exempt Entities

1. Applicable Entities

• Tax-exempt organizations, state or local governments, Indian tribal governments, Alaska Native Corporations, the Tennessee Valley Authority, and rural electric cooperatives may make an election for direct pay.
• The term “any organization exempt from the tax” includes all organizations exempt from tax under § 501(a). 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 or the District of Columbia, Indian tribal governments, U.S. territory, or political subdivision thereof qualify as applicable entities.
• Other than for § 45Q, § 45V or § 45X credits, partnerships and S corporations may not make direct pay elections. Thus, applicable entities that want to pool their resources in order to invest in a renewable energy project would need to do so in a context other than a partnership. However, an applicable entity may hold an applicable credit property through a disregarded entity and make a direct pay election as the tax owner of the applicable credit property. Applicable entities also may hold applicable credit property jointly through unincorporated joint ventures, such as a joint tenancy-in-common or pursuant to a joint operating arrangement.

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. The proposed regulations elaborate on the effect of the trade or business rule by clarifying that it allows tax-exempt and government entities to take advantage of credits outside of 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

• Income from certain 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.

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 (carbon capture), § 45V (clean hydrogen) and § 45X (clean energy manufacturing). The election is available for the first five years of the credit period, after which the credits again become nonrefundable for those taxpayers.

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.

3. Direct Pay for Transferee Taxpayers

• The proposed regulations provide 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.

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