United States: Inflation Reduction Act Direct Pay Rules Finalized

Highlights

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.

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.

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.

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.

• 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.

• 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.

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

• 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

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.

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.

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.

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.

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.

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.

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.