Article By DWGP Summer Associate Alec Peters - University of Colorado Law School 2024
On June 14, 2023, the Internal Revenue Service (“IRS”) issued proposed rules for implementing the direct pay and transferability provisions of the Inflation Reduction Act (“IRA”), which was enacted in August 2022. Direct pay (also referred to as elective pay) allows certain tax-exempt and government entities that do not owe federal income taxes to receive a payment equal to the full value of the tax credits for building certain qualifying clean energy projects or making qualifying investments. The transferability provisions allow entities who do not qualify for direct pay to transfer all or a portion of certain tax credits to a third-party in exchange for tax-free immediate funds. The IRS released proposed rules to implement these provisions, including temporary rules on the pre-filing registration requirements that entities must comply with before making a direct pay or transfer election on their tax return.
“Applicable entities” eligible to make direct pay elections include (1) tax-exempt entities; (2) States and their agencies, instrumentalities, and political subdivisions; (3) the Tennessee Valley Authority; (4) Indian Tribes and their agencies, instrumentalities, and subdivisions; (5) Alaska Native Corporations; and (6) rural electric cooperatives. Twelve tax credits are eligible for direct pay:
- Alternative fuel vehicle refueling property credit (section 30C);
- Renewable energy production credit (section 45 PTC);
- Clean electricity production credit (section 45Y, technology-neutral PTC going into effect in 2025);
- Energy credit (section 48 ITC);
- Clean electricity investment credit (section 48E, technology-neutral ITC going into effect in 2025);
- Credit for carbon dioxide sequestration (section 45Q);
- Zero-emission nuclear power production credit (section 45U);
- Credit for production of clean hydrogen (section 45V);
- Credit for qualified commercial vehicles (section 45W);
- Credit for advanced manufacturing production (section 45X);
- Clean fuel production credit (section 45Z); and
- Qualifying advanced energy project credit (section 48C).
Taxpayers that do not otherwise qualify as “applicable entities” can choose to be treated as an “applicable entity” and make a direct pay election, but only for the section 45Q, 45V, and 45X credits.
The direct pay proposed rule enables applicable entities to combine grants and forgivable loans (i.e., tax-exempt amounts) with the benefits of direct pay for certain tax credits. The rule provides that if an investment-related credit property (i.e., applicable credit property described in sections 30C, 45W, 48, 48C, or 48E of the Internal Revenue Code) is funded by a tax-free grant or forgivable loan, applicable entities would get the same value of the eligible tax credit as if the investment were financed with taxable funds, provided that the tax credit amount plus the tax-exempt amounts do not exceed the cost of the investment-related credit property. This rule is important for applicable entities who want to claim the benefits of both direct pay in the IRA and federal and other funding opportunities in the IRA and Infrastructure Investment and Jobs Act for clean energy projects that may be eligible for the section 30C, 45W, 48, 48C, and 48E credits.
The transferability provisions of the IRA allow any taxpayer who is not eligible for direct pay to elect to transfer all or a portion of certain eligible tax credits to an unrelated transferee taxpayer in exchange for cash, rather than using the credits against the eligible taxpayer’s own federal income tax liabilities. Eligible credits for a transfer election include all the credits listed above that are eligible for direct pay, except the credit for qualified commercial vehicles (section 45W).
The IRS also published temporary rules on the pre-filing registration requirements that entities must comply with to make either a direct pay or credit transfer election on their tax returns. Entities must complete the registration process for each credit property for which they intend to make a direct pay or transfer election. Registration will be done through an online portal, which the IRS expects to be available later this year, and will involve submitting a substantial amount of information including taxpayer details, proof of eligibility, and detailed information on the applicable credit property. Following completion of the registration process, an entity will receive a registration number for each individual credit property for which it intends to make a direct pay or credit transfer election. Each registration number must then be included on the entity’s tax returns for that year and is valid only for the taxable year for which it is obtained.
For more information on the IRA and navigating direct pay and credit transfer elections, including eligibility, applicable credits, timing, and registration, please contact Keith Gordon or Gelane Diamond.
The text of the proposed and temporary rules, as well as answers to frequently asked questions, can be found on the IRS website here.
