Guidance Clears the Way for Direct Pay – Treasury Releases Preliminary “Elective Payment” Regulations
On June 14, 2023, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (the “Service”) issued proposed regulations and temporary 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”).2 These regulations were issued on the same day as the proposed and temporary regulations governing transferability, which are described in our prior client alert found here.3
Along with providing for transferability, the Inflation Reduction Act of 2022 (the “IRA”) provides that, for taxable years beginning after December 31, 2022, “applicable entities”4 may elect to treat certain tax credits5 as a payment against U.S. federal income tax — potentially turning the applicable tax credit into a cash payment from the government.6 Taxpayers that are not “applicable entities,” may make a direct pay election as an electing taxpayer for a limited period for the clean hydrogen production credit (Code section 45V), carbon oxide sequestration credit (Code section 45Q), and the advanced manufacturing production credit (Code section 45X).7
Noteworthy provisions and clarifications found in the over 100 pages of direct pay proposed regulations (REG-101607-23) include:
- In addition to those entities listed in the statute, “applicable entities” include all organizations exempt from the tax imposed by Subtitle A of the Code by section 501(a) (commonly referred to as “tax-exempt organizations”), any agency or instrumentality of any state, the District of Columbia, Indian tribal government, U.S. territory, or political subdivision thereof, subdivisions of Indian tribal governments, and governments of any U.S. territory, or a political subdivision thereof.
- “Applicable entities” do NOT include partnerships.
- As a result, a partnership is an eligible taxpayer that can elect for transferability under Code section 6418, but cannot elect for direct pay under 6417 (even if 100% of its partners are applicable entities).
- Partnerships may be “electing taxpayers,” similar to non-applicable entity taxpayers being able to elect for direct payment with respect to the clean hydrogen production credit (Code section 45V), the carbon oxide sequestration credit (Code section 45Q), and the advanced manufacturing production credit (Code section 45X) (as described further below).
- In lieu of holding an interest in a partnership, an “applicable entity” can enter into an arrangement with other entities and hold an undivided ownership in which the partners or members hold such interest as a tenancy-in-common interest or through a partnership that has elected out of taxation under the partnership regime within the meaning of Code section 761(a) in credit eligible property. Such “applicable entity” would be entitled to elect for direct pay in respect of its undivided ownership or tenancy-in-common interest (while the other entity could self-monetize its share of the credit or be entitled to transfer credits in respect of its interest).8
- “Applicable Credits” for which a direct pay election can be made include “bonus credits.”
- Under the proposed regulations, applicable entities that purchase a credit under Code section 6418 may not elect for direct pay of such credits; however, the preamble specifically requests stakeholder comment on this issue and appears to indicate that there may be certain circumstances in which it would be reasonable to permit a credit buyer to make a direct pay election (e.g., where the purchaser of the Applicable Credit is involved in the development or operation of the project).
- Applicable entities that were passed an ITC through an inverted lease transaction or a 45Q credit through a Code section 45Q(f)(3)(B) election may not elect for direct pay of those credits.
- Generally, it appears as though required filing and administration procedures are consistent in Code sections 6417 and 6418, and it seems Treasury and the Service are viewing direct pay and transferability as similar options for distinct groups.
- As with transferability, a separate direct pay election must be made on a facility/property basis (with an exception for ITCs if made on a project basis).
- A direct pay election applies to the entire amount of applicable credit(s) determined with respect to each applicable credit. Once made, the election is irrevocable and applies throughout the term of the credit.
- The election must be made on the tax return for the year in which the credit is generated (and no later than the due date for such return, with extensions).9
- Similar to the transferability guidance, the relevant entity must pre-register credit eligible property and produce the registration number on the tax return at filing. A direct pay election will be invalid without a registration number.
- “Electing Entities” are entities that are not “applicable entities” but are eligible to elect direct pay for clean hydrogen production credit (Code section 45V), carbon oxide sequestration credit (Code section 45Q), and the advanced manufacturing production credit (Code section 45X).
- This election is made for the taxable year in which the election is made and each of the four subsequent taxable years ending before January 1, 2033.10
- The proposed regulations provide that such an election may only be made once (i.e., you cannot re-elect for a new direct pay period for the advanced manufacturing production credit once the original 5-year period expires).
- To the extent the applicable credit is generated in taxable year(s) subsequent to the expiration of the 5-year election period, entities that are eligible taxpayers may transfer such credit pursuant to Code section 6418.
- If credit eligible property is financed with certain “Tax Exempt Amounts” (e.g., government grants), such Tax Exempt Amounts will not reduce the amount of credit available for direct pay as long as the Tax Exempt Amount plus the amount of the credit does not exceed the basis of the property used for calculating the applicable credit.
- Similar to transferability, entities electing for direct pay are subject to recapture and liability for excessive credits (with a 20% penalty unless reasonable cause is shown).
Treasury also released temporary regulations setting forth mandatory information and registration requirements for taxpayers planning to make a Code section 6417 election.
1 While these regulations refer to “direct pay” as “elective payments,” we have continued to refer to the mechanic as “direct pay” in this alert.
2 Prior to issuing final regulations, Treasury and the Service will accept comments on the proposed regulations prior to August 14, 2023, and plan to hold a public hearing on August 21, 2023.
3 The IRS also released FAQs on direct pay and transferability found here.
4 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 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.
5 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).
7 This preferred direct pay treatment for hydrogen, carbon capture and sequestration, and advanced manufacturing provides these more nascent technologies, and potentially less financeable credit types, ability to efficiently monetize these credits. Following the 5-year direct pay period, these projects types will presumably have shown proof of concept and eligibility for the credit, making financing much easier.
8 Note that this would require that the arrangement not be characterized as a partnership for U.S. federal income tax purposes and that the parties elect out of subchapter K under Code section 761. Stakeholders will need to take care not to inadvertently be prohibited from making an election out of subchapter K under Code section 761.
9 The election may not be made pursuant to amended returns or administrative relief for late filing.
10 Note that while applicable entities may elect direct pay for each year the credit is generated, electing taxpayers are only eligible to elect and receive direct pay for this period.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.