The Internal Revenue Service (IRS) and Department of the Treasury (Treasury) recently released proposed and temporary regulations, and issued a set of frequently asked questions covering the Inflation Reduction Act (IRA) direct pay option available for certain taxpayers (applicable entities) to monetize energy credits under the Inflation Reduction Act (IRA). The regulations provide clarifying definitions, special rules and registration requirements taxpayers must follow to utilize the direct payment election.
Key takeaways
Applicable entities must go through a pre-filing registration process with the IRS before they can make a direct pay election.
The election must be made on a timely-filed original return, which includes extensions of time to file. The election cannot be made or revised on an amended return or through an administrative adjustment request and late election relief procedures are not available.
Agencies and instrumentalities are included in the definition of applicable entities (which also include tax-exempt organizations, state and local governments, the Tennessee Valley Authority, Indian Tribal governments, Alaska native corporations and certain rural electric cooperatives).
Special rules cover how applicable entities that do not have tax return filing requirements make the election.
Background
The IRA introduced a brand new “direct pay” concept under Internal Revenue Code section 6417, which allows eligible entities to elect to treat certain energy tax credits as payments of tax on a return, generating refundable credits (elective payment election). The election was introduced to expand access to the IRA’s energy credit regime by providing entities that generally do not have annual tax liabilities a mechanism for monetizing them. Credits for which applicable entities can make the elective payment election are the:
All taxpayers can elect to be an applicable entity and claim a direct payment for the sections 45Q, 45V and 45X credits. This special election is available for the first five years of the 45Q and 45V credits, and for any five years within the ten-year credit period for the 45X credit. In the case of a partnership or S corporation, only the entity can make the election; its partners or shareholders may not.
Temporary regulations – pre-filing registration process
Section 6417 invites Treasury to require information from or registration by applicable entities before they can properly make an elective payment election. In response, a pre-filing registration process is implemented by the temporary regulations, which broadly requires an applicable entity or taxpayer electing to be treated as such to:
1. Complete an electronic pre-filing registration process through an IRS online portal,
2. Satisfy various registration requirements and receive a unique registration number prior to making an elective payment election,
3. Obtain a registration number for each item of property that will give rise to a credit and for which the elective payment election will be made, and
4. Provide information including but not limited to its name, address, taxpayer identification number, entity type, the credits they intend to pursue and the underlying property giving rise to the credit to avoid fraud and improper or excess direct payments.
Successfully accomplishing the above is not a confirmation of eligibility for the underlying credit(s) for which the elective payment election will be made. However, an elective payment election will not be effective unless the applicable entity receives a valid registration number. An applicable entity’s registration number is only for the taxable year for which it is obtained and must be renewed as applicable. The number must be reported on the tax return with which the elective payment election is made. The temporary regulations separately implement registration processes taxpayers must follow to claim the advanced manufacturing credit under section 48D, and to take advantage of the IRA’s transferability provision under section 6418. A tax alert on section 48D is forthcoming. A separate tax alert on transferability is also released.
Proposed regulations
Applicable entities
The proposed regulations clarify the definition of applicable entity as it covers several listed entities, and any agency or instrumentality of any state, D.C. or U.S. territory, or political subdivision thereof, are all applicable entities. Agencies, instrumentalities and political subdivisions of Indian Tribal governments are included as well.
The proposed regulations indicate that taxpayers eligible to elect to be treated as applicable entities include any person (i.e. individuals and entities) “subject to any internal revenue tax, including income taxes, employment taxes, and excise taxes,” though as noted above, partners in a partnership and shareholders in an S corporation are ineligible. Special rules provide that owners of disregarded entities can make elective payment elections for qualifying property held by the disregarded entity, and owners of unincorporated joint ventures can make the election for their deemed undivided interest in the venture’s qualifying property.
Definitions and rules for making elective payment elections
Elective payment amount
The proposed regulations define the elective payment amount for applicable entities or taxpayers electing to be treated as such (with the exception of partnerships and S corporations, which are covered by a separate definition), as the above-listed credits for which an election is made to be treated as making a payment against the tax imposed by subtitle A (broadly, income taxes) for the taxable year. This amount is calculated by adding the above-listed credits that would be allowed as a general business credit under section 38 for the taxable year, plus the amount of any unused credit that would be carried back or forward as a general business credit under section 39.
To calculate the amount for which an elective payment election can be made, the taxpayer would:
1. compute their current year federal tax liability and the amount of such tax liability that can be offset by credits
2. calculate the amount of current year credits and credits carried forward to the current year
3. offset the tax liability from the first step with the credits calculated in the second step
4. identify the current year above-listed credits not used to offset tax liability
5. reduce the above-listed credits by the amount of the elective payment amount
Generally, the calculation determines the amount of current year above-listed credits that would offset current year tax liability and then the remaining amount can be part of the elective payment amount.
The elective payment amount would be treated as a refundable payment towards the taxpayer’s federal tax liability. For a partnership or an S corporation, the elective payment amount is the amount of the above-listed credits in the same manner as for any other taxpayer, but that results in a payment by Treasury to the entity (unless the entity should owe a tax, it will be treated as a satisfaction of that liability). Elective payment amounts are treated as tax-exempt income in the hands of the entity, and thus increase the owners’ tax bases in their interests. The basis of credit-eligible property giving rise to the elective payment amount must be reduced by 50 percent of that amount.
Election made on annual tax return
Section 6417 calls for the elective payment election to be made on an applicable entity’s or electing taxpayer’s “return of tax for the taxable year for which the election is made,” and for Treasury to provide guidance to applicable entities without tax return filing requirements. The proposed regulations clarify applicable entities or electing taxpayers to make the elective payment election as follows:
1. For any taxpayer required to file an annual tax return with the IRS, on such annual return (i.e. Form 1065, U.S. Return of Partnership Income or Form 990-T for organizations with an unrelated business income tax liability),
2. For taxpayers located in the U.S. territories and not required to file an annual tax return with the IRS, on the return they would be required to file if they were in the U.S.,
3. For entities such as states, D.C., local or Indian Tribal government entities, on Form 990-T, and
4. For short-year filers, on the short year tax return.
Elective payment elections must be made on the timely-filed returns listed above, including extensions. Elective payment elections cannot be made or modified on amended returns or via administrative adjustment requests. Further, late election relief procedures will not be available. Once made, the election is irrevocable and applies to any credit the election is made for that taxable year.
The payment will be deemed made on the later of either the due date of the return (without extensions) on which the elective payment election is made, or the date the return is filed.
Excessive payments and recapture rules
If an applicable entity or electing taxpayer claims a larger direct payment than they are entitled to, absent demonstrating reasonable cause, they will be subject to tax in an amount equal to the sum of the excess, and 20% of that excess (regardless of whether the taxpayer is normally subject to tax).
Additionally, recapture rules apply if the underlying property giving rise to the elective payment ceases to be credit eligible. The recapture amount ranges from 100 to 20 percent of the elective payment amount for investment tax credit property, depending on the length of time that passes after it was placed in service, and similarly to excessive payment amounts, would be considered tax due from the taxpayer. The taxpayer would increase their basis in the applicable by property by half of the recapture payment.
Cannot “double dip” with credit transferability provision
The proposed regulations provide rules for reducing the amount of credit subject to an elective payment election by the amount of the elective payment election. Also, an applicable entity cannot purchase credits from an entity not eligible to make an elective payment election pursuant to section 6418 and then make an elective payment election with regards to those credits.
Effective date
The temporary regulations will apply to tax years ending on or after the date they are published in the Federal Register. The proposed regulations apply to taxable years ending on or after the regulations are published as final in the Federal Register. Entities may rely on the proposed regulations for tax years ending before the date the Treasury publishes final regulations in the Federal Register, provided the entities follow the proposed regulations in their entirety.
For more information on this topic, or to learn how a Baker Tilly specialist can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
