ARTICLE
21 March 2024

Inflation Reduction Act Direct Pay Rules Finalized

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Holland & Knight

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Holland & Knight is a global law firm with nearly 2,000 lawyers in offices throughout the world. Our attorneys provide representation in litigation, business, real estate, healthcare and governmental law. Interdisciplinary practice groups and industry-based teams provide clients with access to attorneys throughout the firm, regardless of location.
As provided in the Inflation Reduction Act (IRA), certain taxpayers may elect to receive direct payment of many of the tax credits included in the law.
United States Tax
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Highlights

  • As provided in the Inflation Reduction Act (IRA), certain taxpayers may elect to receive direct payment of many of the tax credits included in the law.
  • The U.S. Department of the Treasury and IRS recently finalized regulations on the rules and procedures regarding direct payment (sometimes referred to as "elective pay") of these credits. The final regulations do not differ greatly from the proposed rules but nevertheless provide much-needed certainty for those seeking direct payment for their 2023 tax year and later years.
  • Simultaneously, proposed regulations under Section 761 of the Internal Revenue Code were issued that would provide additional flexibility in limited circumstances for partnerships and other unincorporated organizations with a tax-exempt partner. Public comment is sought on that guidance.
  • Additionally, Notice 2024-27 was issued seeking public comment on the ability to elect direct payment for credits that were transferred under Section 6418, an option referred to as "chaining."

The U.S. Department of the Treasury and IRS released final regulations under Section 6417 of the Internal Revenue Code, as enacted by the Inflation Reduction Act (IRA). Section 6417 allows certain taxpayers to elect to receive a direct payment (i.e., make an elective payment election) in lieu of a tax credit. Specifically, under Section 6417, "applicable entities" (generally speaking, entities exempt from federal income tax) can seek direct payment of 12 of the IRA's tax credits.

Holland & Knight Insight

Most of the IRA's tax credits can be directly paid under Section 6417. The 12 credits, considered "applicable credits," are those found at Sections 45 (production tax credit, or PTC), Section 45Y (clean electricity PTC, sometimes referred to as the "tech-neutral" PTC), Section 30C (alternative fuel vehicle refueling property credit), Section 45Q (credit for carbon oxide sequestration), Section 45U (zero-emission nuclear power PTC), Section 45V (clean hydrogen PTC), Section 45W (credit for qualified commercial clean vehicles), Section 45X (advanced manufacturing PTC), Section 45X (clean fuel PTC), Section 48 (investment tax credit, or ITC), Section 48E (clean electricity ITC, sometimes referred to as the "tech-neutral" ITC) and Section 48C (tax credit for qualifying advanced energy projects).

In addition, certain "electing taxpayers" (i.e., those not considered applicable entities) can seek direct payment, but only with respect to tax credits under Sections 45V, 45Q and 45X and only for part of the credit eligibility period.

In all instances, the tax credit is treated as a payment against tax liability and allows the applicable entity or electing taxpayer to receive a cash payment (to the extent the entity has any tax liability, the cash payment is first used to offset that liability).

The final regulations provide certainty on the rules and procedures for electing direct payment. Except as noted below, the final regulations largely mirror those proposed in summer 2023. (See Holland & Knight's previous alert, "Inflation Reduction Act: Answers to Key Questions on Direct Pay and Transferability," June 26, 2023.) The final regulations apply to taxable years ending on or after March 11, 2024. However, for taxable years ending before March 11, 2024, taxpayers may choose to apply the proposed regulations, provided that taxpayers apply the proposed rules in their entirety and in a consistent manner.

Simultaneously to issuing the final regulations, the Treasury Department and IRS issued 1) proposed regulations under Section 761 on the discrete issue of direct payment for partnerships and other unincorporated organizations (Proposed 761 Regulations), and 2) Notice 2024-27, regarding whether a taxpayer that acquires tax credits transferred under Section 6418 can in turn seek direct payment with respect to the same transferred tax credits. The proposed regulations and notice represent a significant deviation from the Treasury Department and the IRS' prior positions on these issues.

This Holland & Knight alert summarizes some of the issues contained in the guidance referenced above.

Elective Payment Election of Applicable Credits

Under Section 6417, "applicable entities" include tax-exempt organizations, states or political subdivisions thereof, governments of U.S. territories or political subdivisions thereof, Indian tribal governments, Alaska Native Corporations (ANCs), the Tennessee Valley Authority (TVA), rural electric cooperatives and U.S. territories. Agencies and instrumentalities of state, local (e.g., municipal), tribal and U.S. territorial governments also generally fall within the definition of "applicable entity" under Section 6417.

The final regulations include limited modifications from the proposed regulations. These modifications broaden the scope of the entities eligible for direct payment of tax credits. For example, the final regulations confirmed that tribal corporations incorporated under Section 17 of the Indian Reorganization Act of 1934 or Section 3 of the Oklahoma Indian Welfare Act are disregarded entities for purposes of the credits. Applicable entities may seek direct payment for credits determined with respect to property held directly by a Section 17 corporation or other disregarded entity they control.

The final regulations also provide a special rule with respect to mirror-code territories. The regulations provide that Section 6417 and the final regulations thereunder will not be treated as part of the income tax laws of the U.S. for purposes of determining the income tax laws of any U.S. territory with a mirror code tax system, unless such U.S. territory elects to have Section 6417 and the final regulations be so treated. This means that Section 6417 and the final regulations are not automatically mirrored in the territories of Guam, the U.S. Virgin Islands and North Mariana Islands.

Holland & Knight Insight

Though the final regulations regarding the definition of "applicable entities" as it relates to territories is favorable, the final regulations provide a reminder that there are restrictions related to property located or used in U.S. territories that predate the IRA. Specifically, there are rules relating to the investment-related tax credits (that is, Sections 30C, 45W, 48, 48C and 48E credits) that generally provide that credit-eligible property cannot be used predominantly outside the U.S. unless the property is owned by a U.S. corporation or U.S. citizen. Therefore, property used in the territories and owned by a territory government or an entity created in or organized under the laws of a U.S. territory generally would not qualify for the investment-related credits. Such restrictions do not apply to the production credits eligible for direct pay.

Additional Guidance Regarding Applicable Entities

As noted above, Section 6417 lists the types of entities that fall within the definition of an "applicable entity" that are eligible to seek direct payment. The final regulations generally continue to exclude partnerships and S corporations from the statutory definition of "applicable entities" – although, under certain circumstances, a partnership or an S corporation (as an "electing taxpayer") can make an election to be treated as an "applicable entity" for the limited purpose of making an elective payment election with respect to tax credits under Sections 45V, 45Q and 45X for limited periods.

In a welcomed reprieve from these otherwise restrictive rules in the final regulations regarding partnerships and other unincorporated organizations, the Treasury Department and IRS simultaneously issued proposed regulations under Section 761 (Proposed 761 Regulations) that provide additional guidance for certain unincorporated organizations that have applicable entities as owners to elect out of the partnership rules under Subchapter K.

Holland & Knight Insight

The proposed 761 Regulations, provide partnerships a possible path for making an elective payment election with respect to the tax credits under Section 45 (renewable electricity production), Section 45U (zero-emission nuclear power production), Section 45Y (technology-neutral clean electricity production), Section 48 (investment tax credit) and Section 48E (technology-neutral investment tax credit), as long as all other requirements under Section 6417 and the Proposed 761 Regulations are satisfied.

Notably, this election is not available for energy storage, hydrogen, clean fuels, qualified biogas property or carbon capture. Taxpayers with joint ownership structures using one of these non-electricity generation technologies should strongly consider submitting comments in response to the Proposed 761 Regulations.

In order for an unincorporated organization to elect out of the partnership rules under Subchapter K, the proposed 761 Regulations would require that the following four requirements be met:

  • First, the unincorporated organization must be owned (at least partially) by an "applicable entity" as defined under Section 6417 and the final regulations.
  • Second, the unincorporated organization's members must enter in a joint operating agreement with respect to the "applicable credit property" (i.e., the electricity generating energy property/facility) in which the members reserve the right separately to take in kind or dispose of their pro rata shares of the electricity produced, extracted or used, or any associated renewable energy credits or similar credits.

Holland & Knight Insight

This second requirement is satisfied even where the members jointly agree to sell all electricity to an offtaker under a long-term power purchase agreement.

  • Third, the unincorporated organization must, pursuant to a joint operating agreement, be organized exclusively to jointly produce electricity from its applicable credit property and for which one or more of the applicable tax credits under Sections 45, 45U, 45Y, 48 and 48E is determined.

Holland & Knight Insight

The third requirement may be satisfied prior to the energy generating property/facility being placed in service (if necessary), provided the unincorporated organization is in the process of completing the property/facility and will operate the property/facility once it is placed in service.

  • Fourth, one or more of the applicable entities that is a member of the unincorporated organization must make an elective payment election under Section 6417 for the applicable credits determined with respect to its share of the applicable credit property.

The Proposed 761 Regulations would provide that members in an unincorporated organization meeting these four requirements would be allowed to own "applicable credit property" (i.e., the electricity generating property/facility) through an entity (other than an entity that is required to be treated as a corporation for tax purposes), including a partnership.

Holland & Knight Insight

The Treasury Department and IRS are considering additional updates to modernize the proposed 761 Regulations and are strongly encouraging comments be submitted via the Federal eRulemaking Portal (indicate IRS and REG-101552-24). All comments must by received by May 10, 2024. Among other things, it is expected that commenters will urge inclusion of all of 12 applicable credits and all technologies incentivized under those credits, rather than just the four proposed credits.

Rules for Making Elective Payment Elections

The final regulations also provide procedural rules for seeking direct payment. Specifically, the due date for making the elective payment election for applicable entities is as follows:

  • in the case of any taxpayer that is not required to file an annual federal income tax return (e.g., a tax-exempt entity), the 15th day of the fifth month after the end of the taxable year

Holland & Knight Insight

Many applicable entities will have never filed a federal income tax return. The final rules provide some flexibility on adopting its taxable year. Specifically, an applicable entity that is not required to file a federal income tax return, but is filing solely to make an elective payment election, may choose whether to file its first return (and thus adopt a taxable year for purposes of Section 6417) based upon a calendar or fiscal year, provided that such entity maintains adequate books and records, including a reconciliation of any difference between its regular books of account and its chosen taxable year, to support making an elective payment election on the basis of its chosen taxable year.

Instructions to Form 990-T, the tax return required for applicable entities that are otherwise not required to file a tax return, provide for limited information required to make the direct pay election.

  • in the case of any taxpayer located in a U.S. territory, the due date (including extensions of time) for the original federal income tax return that would apply if the taxpayer were located in the U.S.
  • in any other case, the due date (including extensions of time) for the original federal income tax return for the taxable year for which the election is made, but in no event earlier than Feb. 13, 2023

Holland & Knight Insight

A prerequisite for the elective payment election on the tax return is completing the pre-filing registration process. Completion of the pre-registration will provide the taxpayer the registration number(s) that must be reported on the taxpayer's annual federal income tax return(s). See Holland & Knight's previous Alert, "Inflation Reduction Act Direct Pay and Transfer Pre-Filing Registration Is Open for Business," (Feb. 6, 2024).

Electing Taxpayers

The final regulations also provide the following guidance with respect to when, and under specific circumstances, an entity that is not an applicable entity (as an "electing taxpayer") (e.g., a partnership, an S corporation or a C corporation) can be treated as an "applicable entity" for the limited purpose of seeking direct payment (i.e., make an elective payment election). Under statute, this is available only with respect to tax credits under Sections 45V, 45Q and 45X for part of the credit eligibility period:

  • Section 45V. An electing taxpayer may make an elective payment election during the taxable year the qualified clean hydrogen production facility is placed in service (or by Aug. 16, 2023, in the case of facilities placed in service before Dec. 31, 2022). The election is available only for the Section 45V tax credit for production of clean hydrogen (e.g., it is not available for taxpayers who seek an investment tax credit for the clean hydrogen production facility under Section 48).
  • Section 45Q. An electing taxpayer may make an elective payment election during the taxable year the single process train has been placed in service (e.g., after Dec. 31, 2022), but only with respect to the Section 45Q tax credit for carbon oxide sequestration related to such a single process train.
  • Section 45X. An electing taxpayer may make an elective payment election for the tax year in which the taxpayer produces, after Dec. 31, 2022, eligible components, but only with respect to the Section 45X advanced manufacturing production tax credit. The election is made on a facility-by-facility basis.

Holland & Knight Insight

Though the elective payment election for the tax credits under Sections 45V and 45Q is made in the year the electing taxpayer places the property in service, such election for the tax credits under Section 45X can be sought for preexisting facilities (i.e., as long as the eligible components giving rise to the Section 45X tax credit are produced and sold to an unrelated party after Dec. 31, 2022).

Unsurprisingly, as required for applicable entities, the final regulations explicitly require electing taxpayers to properly complete the pre-filing registration process. (See Holland & Knight's previous alert, "Inflation Reduction Act Direct Pay and Transfer Pre-Filing Registration Is Open for Business," Feb. 6, 2024.)

Once an elective payment election is made by electing taxpayers, it is effective for the tax year and each of the four subsequent tax years. The final regulations provide guidance on how electing taxpayers can revoke their elective payment election; in all instances, any revocation cannot be reversed. Finally, the rules make clear that the electing taxpayer cannot transfer these credits while an election is effective.

Pre-Filing Registration and Election Logistics

To receive direct payment, an applicable entity or electing taxpayer (collectively, eligible entities) must make an elective payment election. Such election is made on annual federal income tax returns or, if the applicable entity is exempt from filing such a return, on Form 990-T (Exempt Organization Business Income Tax Return (and proxy tax under Section 6033(e))). In all instances, eligible entities must pre-register with and receive a registration number from the IRS before making the elective payment election on their return. The pre-registration must be done electronically on the IRS portal.

Eligible entities must obtain a registration number for each applicable credit property (i.e., each energy property or facility). If a registration number was previously obtained for an applicable credit property, the eligible entity must nevertheless renew the registration each year for any multiyear credit). If the applicable credit property undergoes a change of ownership, then the new owner must re-register it to associate its employer identification number (EIN) with the property.

The elective payment election must be made on the eligible entity's original annual federal income tax return – i.e., the election cannot be made or withdrawn on an amended return. However, eligible entities can make revisions to the election amount on a superseding return (i.e., a return that supersedes a previously filed return and is filed prior to the due date). Additionally, eligible entities can correct a "numerical error with respect to a properly claimed elective payment election" on an amended return or through a Section 6227 administrative adjustment request.

Holland & Knight Insight

Neither the Internal Revenue Code nor regulations define a "superseding return," but administrative IRS guidance provides that a superseding return is a return filed after the originally filed return but before the due date for filing the return (including extensions). For example, if an applicable entity subject to an automatic six-month extension files an original return on the due date (excluding extensions), then files a subsequent return within the automatic extension period, the subsequent return would generally be considered a superseding return. Conversely, unlike a superseding return, an amended return is a return filed after the taxpayer filed an original return and after the due date for filing (including extensions).

In the preamble to the final regulations, the Treasury Department and IRS note that in cases where the pre-filing registration submission is incomplete, the IRS will attempt to contact the registrant using the information provided to indicate deficiencies with the registration prior to making a determination. However, once the IRS determines that a registration number should not be given, taxpayers may not appeal the denial unless the IRS and Independent Office of Appeals agree that such review is available and the IRS provides the time and manner for such review.

Holland & Knight Insight

The IRS is concerned about fraudulent direct pay claims. To this end, taxpayers must provide certain information – signed under the penalties of perjury – as part of the pre-filing registration process. However, if IRS denies the pre-registration filing submission and refuses to provide a registration number, it is unclear what remedies the taxpayer would have. This is similar to the situation taxpayers have when requesting a Section 4101 registration on a Form 637 for fuel tax credits and fuels-related activities.

The IRS recommends that taxpayers provide at least 120 days to receive a registration number, as the IRS may have follow-up questions. Obtaining the registration number is key, as it must be provided on the tax return.

Treatment of Special Enforcement Matters

The final regulations continue to maintain that the elective payment election is deemed a "special enforcement matter" for purposes of the centralized partnership audit regime (BBA) pursuant to Section 6241(11). Under Section 6241(11), in the case of partnership-related items involving special enforcement matters, the BBA (or any portion thereof) does not apply to such items and that such items are subject to special rules as determined necessary for the effective and efficient enforcement.

Holland & Knight Insight

As a result of Treas. Reg. § 301.6241-7(f), the IRS may exceed the statute of limitations set forth in the BBA statute.

Special Rules

The final regulations provide that an additional 20 percent tax is applicable in the case of an excessive payment determined, i.e., the applicable entity or electing taxpayer is not entitled to the amount claimed. The additional 20 percent does not apply if the applicable entity or electing taxpayer demonstrates to the satisfaction of the IRS that the taxpayer had reasonable cause to claim such credit in the amount claimed.

Holland & Knight Insight

The final regulations did not expand or redefine the definition of reasonable cause. Therefore, reasonable cause will continue to be defined under the existing standards and authorities, including Treas. Reg. § 1.6664-4.

These final regulations clarify that if an applicable entity or electing taxpayer amends its tax return or files an administrative adjustment request (AAR) before the IRS opens an examination and the amended return or AAR adjusts the elective payment amount to the amount properly determined with respect to the applicable entity or electing taxpayer, then the excessive payment provisions would not apply, including the additional 20 percent tax.

Holland & Knight Insight

The IRS is treating the 20 percent excessive payment as an additional tax and, if applicable, it would apply in addition to any penalties, additions to tax or other amounts owed. However, beyond the merits, there are defenses and mitigation devices available to the taxpayer to mitigate the 20 percent additional tax.

Notice 2024-27

Finally, along with this other guidance, the IRS issued Notice 2024-27 (Notice) requesting comments on situations in which an elective payment election could be made for a credit transferred under Section 6418, a process referred to as "chaining." Prior proposed regulations would have disallowed a taxpayer who had purchased credits from a transferor under Section 6418 to claim elective payment of such purchased credits.

The future of chaining rules remains uncertain. The Notice states that the Treasury Department and IRS will continue to evaluate whether potential chaining rules would be consistent with the statutory framework and legislative purposes of Sections 6417 and 6418, as well as administrability challenges associated with elective payment elections and transfer elections. The Notice asks for input from the public on several topics. Written comments should be submitted by Dec. 1, 2024.

Holland & Knight Insight

Allowing chaining would be a significant deviation from the proposed rules but would increase substantially the pool of available transferees and have a major impact on the tax credit transfer market. The extended comment period – until Dec. 1, 2024 – indicates that the Treasury Department and IRS are not eager to issue such guidance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

ARTICLE
21 March 2024

Inflation Reduction Act Direct Pay Rules Finalized

United States Tax

Contributor

Holland & Knight is a global law firm with nearly 2,000 lawyers in offices throughout the world. Our attorneys provide representation in litigation, business, real estate, healthcare and governmental law. Interdisciplinary practice groups and industry-based teams provide clients with access to attorneys throughout the firm, regardless of location.
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