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IRS and Treasury Final Regulations on Elective Pay for Clean Energy Tax Incentives Detail New Definitions and Special Rules While Addressing Concerns

Published by Alvin Lee and Peter Lawrence on Wednesday, April 17, 2024 - 1:15PM

The Inflation Reduction Act (IRA) includes multiple provisions that support the production of clean and renewable energy, including the new tax incentive monetization option of elective pay. The Internal Revenue Service (IRS) and the U.S. Department of the Treasury (Treasury) on March 5  released their final regulations on elective pay, also known as direct pay, (T.D. 9988) under Internal Revenue Code (IRC) Section 6417.

In June 2023, the proposed regulations for the elective pay guidelines were released, and there were more than 150 written comments submitted in response. A hearing was then held in August 2023 where speakers requested changes to the proposed regulations. Novogradac partners Nat Eng and Alvin Lee spoke at the hearing to discuss the Novogradac Renewable Energy Working Group’s (RE Working Group’s) comment letter submitted in response to the elective pay proposed guidance. 

In addition to the working group’s review of the proposed guidance, Novogradac has provided resources such as an August 2023 Tax Credit Tuesday podcast detailing the proposed guidance and a podcast on the final regulations from April 9, 2024. 

The final regulations considered the 150 comments from the proposed regulations as well as the discussions from the August 2023 hearing and provided details on new definitions, special rules and more.

Overview of Elective Pay

Elective pay allows an eligible tax-exempt entity to make an election that would treat the entity as having made a tax payment equal to the value of the applicable tax credits that it would otherwise have been eligible to claim (direct-pay election) on its tax return. Elective pay, along with transferability (as authorized under IRC Section 6418), provides new financing opportunities for tax-exempt stakeholders. 

This option makes tax credits “refundable” because it allows entities to claim a refund from the IRS for excess taxes that the entity has paid or deemed to have paid. This allows states, local governments, nonprofits, tribal entities and other tax-exempt organizations to be able to receive a direct payment from the IRS in lieu of a clean energy tax credit. Applicable entities can use elective pay for 12 different clean energy credits. The following list details which credits are eligible for elective pay:

  1. Production tax credit (PTC) for electricity from renewable sources (IRC Section 45, pre-2025)
  2. Clean energy PTC, (IRC Section 45Y, 2025 onwards)
  3. Investment tax credit (ITC) for energy property (IRC Section 48, pre-2025)
  4. Clean energy ITC (IRC Section 48E, 2025 onwards)
  5. Credit for carbon sequestration (IRC Section 45Q)
  6. Zero-emission nuclear power production credit (IRC Section 45U)
  7. Advanced energy project credit (IRC Section 48C)
  8. Advanced manufacturing production credit (IRC Section 45X)
  9. Credit for qualified commercial clean vehicles (IRC Section 45W)
  10. Alternative fuel vehicle refueling property credit (IRC Section 30C)
  11. Clean hydrogen PTC (IRC Section 45V)
  12. Clean fuel production credit (IRC Section 45Z, 2025 onwards)

The following bonus credits may also make use of elective pay: 

  • First, the prevailing wage and apprenticeship (PWA) requirements require that contractors and subcontractors must pay them no less than the prevailing wage rates for corresponding work on similar projects within the same area. The amount of credit awarded is multiplied by a factor of five for projects that meet these requirements. 
  • Next, the domestic content bonus credit applies to renewable energy facilities that are constructed with a minimum percentage of produced and manufactured components from the United States. It enhances the amount of credit allocated to eligible projects or facilities by a factor of 10% for the PTC, or up to 10% for the ITC. The credits that are a PTC are Sections 45 and 45Y, and the credits that have an ITC are Sections 48 and 48E. Projects that begin construction in 2024 that use elective pay could see a reduction in the PTC if the domestic content requirements are not met. 
  • Third, the energy communities bonus credit gives projects that are in communities that have historically been the location of energy projects, including projects in areas containing closed coal mines or coal-fired power plants, up to a 10% increase in the ITC and a full 10% increase in the PTC. The bonus will be available to brownfield sites and to areas with significant employment or local tax revenues from fossil fuels and unemployment rates that are higher than average. 
  • Lastly, the low-income communities bonus credit increases a credit amount by 10 to 20 percentage points to certain families in low-income communities, Indian lands, or federal housing developments. It can also go towards families serving low-income households.

Final Regulations Provide Details on New Definitions and Special Rules

The final regulations clarified the definition of an “applicable entity” and finalized details of pre-filing registration. Additionally, the final regulations provided rules for determining the tax year for entities that previously did not have a federal income tax return filing obligation and explained a special rule on tax-exempt grants and forgivable loans. Lastly, Treasury and IRS finalized guidance for elective pay relating to partnerships and S-corporations and finalized their decision to prohibit the concept of chaining credits.

1. Definition of Applicable Entity

The definition of applicable entity was finalized to include tax-exempt organizations, U.S. territory governments and their political subdivisions, states and political subdivisions (such as local governments), Indian tribal governments and their subdivisions, agencies and instrumentalities of state, local, tribal and territorial governments, Alaska native corporations, The Tennessee Valley Authority and rural electric co-operatives. This definition differs from the original proposed definition by including agencies and instrumentalities of the state, subdivisions of Indian tribal governments and territorial governments.

2. Final Details on Time and Manner of Pre-Filing Registration

As of March 8, the IRS and Treasury stated that around 500 entities have registered and requested registration numbers for more than 45,500 total facilities or projects for elective pay, transferability and CHIPS functionality. They also stated that of the registered entities, 50% can use elective pay. 

The finalized regulations rule that pre-filing registration is mandatory for applicable entities that wish to use elective payment for applicable credits. The pre-filing registration can be made through the IRS portal, and each member of a consolidated group is required to complete this registration prior to making an elective payment. The regulations state that an applicable entity or electing taxpayer must register before claiming an elective payment, and each applicable credit property must have its own registration number. 

Applicants must provide general information, information about tax-exempt status, the taxpayer’s taxable year, the type of annual returns filed, the type of applicable credits intended to use and information about the applicable credit property. Additional resources are provided for renewing registration numbers as they expire after one year, as well as for making amendments to previously submitted registration information. The IRS will be monitoring the uptake and efficiency of registration and implementation of the credits, and more information may be requested as a safeguard if there are suspicions of fraud or improper use. 

3. Rule for Determining Tax Year for Entities that Do Not Have a Federal Income Tax Return Filing Obligation

The final regulations state that a taxpayer, that is not required to file a federal income tax return, can adopt a taxable year which is based upon a calendar year or fiscal year using Form 990-T as long as they maintain proper records, including a reconciliation of any difference between its regular books of account and chosen taxable year. In a March 5 seminar held by the Treasury, Seth Hanlon, deputy assistant secretary for tax and climate policy in Treasury’s Office of Tax Policy, gave the following example: A town can choose to file a Form 990-T using a calendar year, enabling it to make an elective pay election with respect to an applicable property regardless of when it was placed in service during a calendar year. The town has no federal income tax return requirement under 6033(a) of the Code but is filing a Form 990-T for the sole purpose of using elective pay.

Blog Graphic: Determining a Tax Year for Entities that do not have a Federal Income Tax Return Filing Obligation

4. Special Rule on Tax-Exempt Grants and Forgivable Loans

The final regulations allow entities to combine grants and forgivable loans with tax credits through a special rule. For an ITC property acquired with amounts from grants and forgivable loans that are exempt from taxation, the regulations separate the special rule into two parts:  

  1. an “amounts included in basis” rule (allowing tax-exempt amounts to count toward basis), and 
  2. a “no excess benefit from restricted tax-exempt amounts” rule (not allowing restricted tax-exempt amounts plus the amount of the credit to exceed the cost of the ITC property).

The no-excess-benefit rule applies for the specific purpose of purchasing, constructing, reconstructing, erecting, or otherwise acquiring an investment-related credit property. If the no-excess-benefit rule is used, the applicable credit will be used to treat the property as being used in a trade or business of an applicable entity. This would subject the applicable credit to taxable entities’ general tax principles.

5. Partnerships, S-Corporations and the Double Benefit Rule

Entities treated as partnerships for federal tax purposes (or S corporations) are not allowed to make elective payment elections, except with respect to a Section 45V credit, Section 45Q credit, or Section 45X credit. The final regulations state that for any election made by a partnership or S corporation, the Secretary shall make a payment to such partnership or S corporation equal to the amount of such credit and the denial of double benefit rule shall be applied before determining a partner’s distributive share, or shareholder’s proportionate share. The denial of double benefit rule states that if an applicable entity makes an election under Section 6417, the credit will be reduced to zero for the taxable year. Any amount with respect to any applicable credit election of Section 6417 will be treated as tax-exempt income for the purposes of the determination of basis the basis of a partner’s interest and the pass-through of items to shareholders. Lastly, a partner’s distributive share of the tax-exempt income will be based on the partner’s distributive share of the otherwise applicable credit for each taxable year. 

6. Despite Hearing Comments, IRS Makes Chaining Unallowed

One concept addressed during the Aug. 2023 hearing on the elective pay proposed rules was the concept of “chaining,” which would allow for an applicable entity or electing taxpayer pursuing elective pay for credits transferred pursuant to Section 6418 or credits acquired by a lessee from a lessor (a lease-pass through transaction). The regulations by Treasury and IRS explicitly prohibit chaining due to the risk of fraud or misuse, but further comments were requested on the chaining of clean energy credits on March 5. The comments are due Dec. 1.

Co-Owned Electricity-Producing Properties Can Now Make Elective Payments

The final regulations provided that partnerships are not applicable entities. However, if an applicable entity is a co-owner in an applicable credit property through an organization that has made a valid election to be excluded from the application of the partnership tax rules under subchapter K, then the entity’s undivided ownership share of the applicable credit property would be eligible for elective pay. Following the release of the finalized elective pay rules, the IRS and Treasury released a Notice of Proposed Rulemaking for section 761, which clarifies how applicable entities that co-own electricity-producing applicable credit properties to make an elective payment with respect to each party’s respective shares of the property. Section 761 would require that unincorporated organizations be at least partially owned by an applicable entity and that the two parties must enter a joint operating agreement. The joint operating agreement states that both the applicable entity and the unincorporated organization reserve the right 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. After the agreement is created, the resulting entity should be organized to jointly share the production of electricity from its applicable credit property. Finally, a member of the unincorporated organizations must make an election payment under Section 6417.

Next Steps for Elective Pay

To assist stakeholder in understanding the complexities of final regulations, the IRS is hosting several online events on April 10, 17, and 24 for all elective pay applicants to help with the navigation of the Energy Credits Online portal and the pre-filing registration process. These sessions will build upon a March 5 webinar on elective pay and the pre-filing registration process that was hosted by the White House and Treasury. Treasury and IRS have also released a list of publications to provide more information surrounding elective pay, in addition to an FAQ site.

The Novogradac 2024 Spring Renewable Energy Tax Credits Conference on May 16-17 in San Diego offers networking and professional development opportunities with renewable energy industry insiders. 

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