Maximize your section 45X tax credit ahead of tax season | Baker Tilly

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Maximize your section 45X tax credit ahead of tax season | Baker Tilly

What is section 45X?

The section 45X tax credit is a federal tax incentive designed to reward domestic manufacturers for producing qualifying advanced energy components. These include solar and wind energy components, battery modules, inverters and the refining or recycling of critical minerals.

In October, the Treasury released section 45X final regulations, including the new rules for critical minerals, it's even more crucial for manufacturers to understand the additional nuances or opportunities. The addition of mining and extraction costs as eligible activities under the 45X credit opens new opportunities but also adds layers of complexity.

Eligible manufacturers can claim the credit directly on their tax return without needing a formal application process, simplifying access to this powerful incentive. The value of the credit is calculated based on specific metrics — such as production volume, electrical capacity or cost — and is fully transferable, allowing manufacturers to sell unused credits for immediate cash benefits.

The program offers full credit benefits presently through 2029, with a phased reduction beginning in 2030. Notably, critical minerals remain exempt from this phase-out. By ensuring long-term visibility into the credit’s value, the 45X incentive has already fueled a significant increase in clean energy manufacturing investment, reflecting its impact on the sector's growth trajectory.

What manufacturers need to know before filing

Navigating the complexities of federal tax credit programs for manufacturers requires thorough due diligence and careful compliance to avoid potential pitfalls. A key requirement for claiming the section 45X advanced manufacturing production tax credit is meeting the IRS’s definition of "substantial transformation." This means that the raw materials or components used in the manufacturing process must undergo significant processing to become a new and distinct product with a different name, character or use. This goes beyond simple assembly or minor modifications. The transformation must fundamentally change the raw inputs into a final product that can be independently sold.

For example, turning raw silicon into solar cells or refining lithium into battery-grade material qualifies as substantial transformation. However, merely assembling imported solar panels or basic processing of materials without significant alteration would not meet this criterion.

This requirement underscores the importance of maintaining detailed records of the manufacturing process, ensuring that each step can be documented and verified as meeting the substantial transformation standard. Failure to properly substantiate this transformation could lead to disqualification from the credit, along with potential audits and penalties.

It’s worth noting that while the finished goods must be manufactured domestically, their subcomponents (such as steel, framing or electrical parts) do not need to originate in the U.S. This flexibility allows manufacturers to leverage global supply chains for constituent materials without jeopardizing eligibility for the credit.

Given the complexities and potential for IRS scrutiny, due diligence is essential. The IRS has emphasized rigorous oversight of tax credits like section 45X to prevent misuse. Manufacturers should carefully evaluate their processes and maintain meticulous documentation to validate their eligibility. The three key requirements to note however are;

Unrelated third-party sale: The manufactured product must be sold to an unrelated third-party to qualify for the 45X credit. Internal transfers or inventory stockpiling are not eligible.
Documentation: Manufacturers must maintain thorough records, including details of the manufacturing process, descriptions of finished goods and proof of sale to third parties.
No prevailing wage requirements: Unlike many other clean energy tax credits, 45X does not require compliance with prevailing wage and apprenticeship standards.

Sale to unrelated third-party

The sale to an unrelated third-party is a critical step in verifying that a substantial transformation has occurred. This requirement ensures that the product resulting from the transformation is genuinely intended for market use rather than for further internal processing or use within the same supply chain. By mandating the sale to an unrelated third-party, the regulation seeks to establish a clear, market-driven valuation and application of the newly transformed product.

Here's how this works in practice:

Market validation: The sale demonstrates that the product has a distinct and independent value in the market, separate from the raw materials used to create it.
Independence: The third-party should be unrelated and have no significant business ties to the producer, ensuring an unbiased transaction that reflects the true value and nature of the transformed product.
Documentation: Proper documentation of the sale, including contracts, invoices and shipping records, supports compliance and provides evidence that the transaction is legitimate and meets the regulatory criteria.

At Baker Tilly, we specialize in helping manufacturers navigate federal tax credit programs, including the complexities of the IRA section 45X tax credit. Our team provides independent assessments to determine eligibility, assists in substantiating claims with proper documentation and helps implement future-state strategies to ensure compliance. We support companies in establishing robust production and sale tracking systems, such as ERP and manufacturing floor tracking systems, to substantiate activities at the individual product level, including serial or lot numbers.

Download our 45X checklist Contact an IRA tax credit specialist