Tax News and Developments March 2024
In brief
On 5 March 2024, Treasury and the IRS published Treas. Reg. § 1.48D-6 (“Final Regulations”), which implements the section 48D(d) election allowing eligible taxpayers to treat the amount of the advanced manufacturing investment credit (“CHIPs Credit”) established under the Creating Helpful Incentives to Produce Semiconductors Act of 2022 (“Act”) as a payment against Federal income tax liabilities, i.e., a “direct pay election” (“Direct Pay Election“).1
Key takeaways
For eligible taxpayers seeking to treat the CHIPs Credit allowed in any tax year as a payment against Federal income tax liabilities in lieu of claiming the credit, the Final Regulations generally retain the structure and framework for administering the election laid out in proposed and temporary regulations, with welcome modifications to clarify key issues relating to the limitations for making the elective payments, the ‘denial of double benefits’ rule, and the election’s pre-filing requirements.
Background
On 23 March 2023, Treasury and the IRS released an initial set of proposed regulations under section 48D to provide detailed guidance on the CHIPs Credit in general. The requirements for making a Direct Pay Election under section 48D(d) were included in Treas. Reg. §1.48D-6.2 Shortly after, in June 2023, Treasury and the IRS released proposed regulations revising Treas. Reg. § 1.48D-6, as originally proposed, to further clarify the Direct Pay Election rules, including the additional information and registration requirements (“Proposed Regulations”).3 At the same time, Treasury and the IRS released temporary regulations to implement the registration requirement described in Treas. Reg. § 1.48D-6 of the Proposed Regulations (“Temporary Regulations”).4
The Final Regulations, taking into account dozens of comments to the Proposed Regulations, as well as testimonies at a public hearing, remove the Temporary Regulations, effective 10 May 2024 (60 days after the Final Regulations were published), and generally adopt Treas. Reg. § 1.48D-6 of the Proposed Regulations with certain modifications.
Direct pay election
The Act created section 48D to provide eligible taxpayers the CHIPs Credit, a 25% investment tax credit for investments in semiconductor manufacturing. More specifically, the CHIPs Credit for any taxable year is 25% of the qualified investment (which excludes basis of property attributable to qualified rehabilitation expenditures) for such year with respect to any advanced manufacturing facility (i.e., a facility for which the primary purpose is manufacturing semiconductors or semiconductor manufacturing equipment) of an eligible taxpayer. The Direct Pay Election allows eligible taxpayers (i.e., taxpayers other than partnerships and S corporations) to elect to treat the amount of the CHIPs Credit as a direct payment against income tax for the tax year (“Direct Payment“).
The Direct Pay Election is an irrevocable election and must be made no later than the due date (including extensions) for the tax return for the tax year for which the election is made. The election must be made on the taxpayer’s original, timely tax return for the year (including a superseding return). The Direct Payment is treated as made on the later of the tax return due date (determined without regard to extensions) for the tax year of the election or the date on which such tax return is filed. The Final Regulations clarify that a Direct Pay Election may not be made or withdrawn on an amended return or by filing an administrative adjustment request under section 6227 (other than correcting a numerical error with respect to a properly claimed election). While there is no relief available under Treas. Reg. § 301.9100-1 or § 301.9100-3 for an election that is not timely filed, the Final Regulations permit an extension of time under Treas. Reg. § 301.9100-2(b) to allow for an automatic six-month extension of time from the due date of the tax return (excluding extensions) to make a Direct Pay Election.
Double benefit denied
Like the Proposed Regulations, the Final Regulations prevent taxpayers from claiming double benefits from the CHIPS Credit and a Direct Pay Election with respect to such credit in the same tax year. For any taxpayer making a Direct Pay Election, the CHIPS Credit is reduced to zero, and, for any other purpose under the Code, the credit is deemed to have been allowed to the taxpayer for such tax year, preventing the taxpayer from being able to claim the CHIPS Credit in the same tax year the taxpayer makes a Direct Pay Election with respect to such credit.
In addition, the CHIPs Credit is a general business credit under section 38, which may be limited by tentative minimum tax and carried back or carried forward to other tax years. Accordingly, the Final Regulations provide taxpayers with rules to take into account general business credit carryforwards and limitations in computing the amount of a Direct Payment. The full amount of the CHIPs Credit is deemed to be allowed for all other tax purposes, including applying the section 50 basis and recapture rules and computing estimated tax underpayments. If a taxpayer makes a valid Direct Pay Election for a tax year and the Direct Payment amount exceeds the taxpayer’s tax liability, the excess amount can be refunded to the taxpayer. If a taxpayer makes a valid Direct Pay Election for a tax year and the Direct Payment amount exceeds the allowable credit, the excess amount is subject to Federal income tax plus 20% of the excess, unless a taxpayer can demonstrate reasonable cause.
Observation: Direct Pay Elections, and the resulting Direct Payments, cannot be applied as a reduction to quarterly estimated tax payments given that a Direct Payment is treated as made on the tax return due date, at the earliest.
Partnerships and S corporations
Special rules apply for a partnership or S corporation making a Direct Pay Election. If a partnership or S corporation makes a valid Direct Pay Election, the IRS makes a Direct Payment to the electing passthrough entity rather than treat the CHIPs Credit as a payment against tax. That payment is treated as tax-exempt income for purposes of sections 705 and 1366.
The amount of the Direct Payment is equal to the CHIPs Credit amount unless the entity owes federal tax, in which case the payment may be reduced by the amount of that tax liability. A partner’s distributive share, or S corporation shareholder’s pro rata share, of tax-exempt income from a Direct Payment is based on the partner’s distributive share, or S corporation shareholder’s pro rata share, of the applicable CHIPs Credit. Such tax-exempt income is treated as arising from an investment activity rather from the conduct of a trade or business and therefore not treated as passive income to any partners or S corporation shareholders who do not materially participate within the meaning of section 469(c)(1)(B).5
Before determining any partner’s distributive share, or S corporation shareholder’s pro rata share, of the applicable entity’s CHIPs Credit, the denial of double beneifts rule applies to reduce such credit to zero and, for any other purposes under the Code, deem the CHIPs Credit to have been allowed solely to such entity (and not allocated or otherwise allowed to its partners or shareholders) for such taxable year. Similarly, any partner’s or S corporation shareholder’s share of any qualified investment in an advanced manufacturing facility for which a Direct Payment Election has been made for the taxable year is reduced to zero for such taxable year.
To calculate the amount of a CHIPs Credit that will result in a Direct Payment, the Final Regulations clarify that the partnership or S corporation calculates the amount of the credit allowable as if an elective payment election were not made and without regard to section 38(c). While the amount of a partnership’s or S corporation’s CHIPs Credit is not subject to the section 469 passive activity limitation, as an investment credit under section 46, the amount of the credit is subject to limitation by at-risk, recapture, and basis adjustment rules.6
An upper-tier partnership that is a direct or indirect partner of a partnership that makes a Direct Payment Election and receives (directly or indirectly) an allocation of tax-exempt income from the applicable Direct Payment must determine its partners’ distributive shares of the tax-exempt income in proportion to the partners’ distributive shares of the CHIPs Credit.
Generally, a partner’s distributive share of tax-exempt income resulting from a Direct Payment is equal to the partner’s distributive share of its otherwise allocable basis in the qualified property. Final Regulations add an interim rule however, providing that for certain partnerships, a partner’s distributive share of tax-exempt income resulting from a Direct Payment may be determined in accordance with the basic partnership allocation principles of Treas. Reg. § 1.704-1(b)(1)(i). This interim rule applies to a partnership if its partnership agreement is a written binding contract that was entered into after 31 December 2021, and before 22 June 2023, and the entity was formed for the purpose of owning and operating an advanced manufacturing facility or qualified property. An S corporation shareholder’s pro rata share of tax-exempt income resulting from a Direct Payment depends on the shareholder’s otherwise apportioned basis in the qualified property for the tax year and is taken into account in the tax year the CHIPs Credit is determined.
Observation: Direct Payments received by a partnership or S corporation need not be distributed under section 48D or the regulations thereunder. The preamble to the Proposed Regulations clarified that there are no restrictions under section 48D on how a partnership or S corporation that receives a Direct Payment from the IRS may use the cash payment in its operations (including when it makes distributions to its partners or shareholders) and the Final Regulations do not change that approach.
Pre-filing registration process
Taxpayers must complete the pre-filing registration process before a Direct Pay Election can be made with respect to a qualified investment in an advanced manufacturing facility. The Final Regulations generally adopt the pre-filing registration requirements described in the Proposed Regulations that a taxpayer, including a partnership or an S corporation, must successfully complete before a Direct Pay Election may be validly made. A Direct Pay Election will not be effective with respect to a CHIPs Credit unless the taxpayer has a valid registration number for the qualified investment, obtained as part of the pre-filing registration process and provides the registration number for each qualified investment on its Form 3800, General Business Credit (or its successor) attached to the timely filed annual tax return for the year. Failure to properly register a qualified investment renders the taxpayer ineligible to receive Direct Payment amounts.
As part of the pre-filing registration process for making a Direct Pay Election, taxpayers must:
- Make a pre-filing registration submission electronically using the IRS Energy Credits Online (ECO) tool, the IRS’ online pre-filing registration portal.
- Obtain a registration number for each qualified investment in an advanced manufacturing facility with respect to which a CHIPs Credit will be determined and for which the taxpayer wants to make a Direct Pay Election.
- Provide information relating to the taxpayer and the qualified investment in an advanced manufacturing facility that would allow the IRS to prevent duplication, fraud, improper payments, or excessive payments under section 48D (e.g., taxpayer’s name, address, taxpayer identification number, and entity type, as well as details about the qualified investment).
Observation: There is no clear timeline for how long it may take for the IRS to review and process pre-filing registration submissions, and with the need to register each qualified investment on an annual basis, the administrative burden of reviewing and processing pre-filing registration submissions may vary. The IRS has recommended that taxpayers submit pre-filing registration submissions as soon as reasonably practicable during the tax year, but at least 120 days prior to when the entity plans to file its tax return making the Direct Pay Election.
On 5 March 2024, the IRS also updated its frequently asked questions regarding elective pay and transferability.
In conclusion
While the Final Regulations adopt, in large part, the Proposed Regulations on which taxpayers have been able to rely, they provide welcome clarity for taxpayers looking to monetize the CHIPs Credit using the Direct Pay Election and the compliance requirements for making a Direct Pay Election. Still, taxpayers and practitioners eagerly await additional guidance on the general administration and other aspects of the CHIPs Credit expected with the finalization of the broader set of regulations initially proposed under section 48D.
1 TD 9989, 89 Fed. Reg. 17,596 (March 11, 2024), which also removes Treas. Reg.§ 1.48D-6T.
2 See Prop. Treas. Reg. § 1.48D-6, as proposed in REG-120653-22, 88 Fed. Reg. 17,463 (March 23, 2023).
3 REG-105595-23, 88 Fed. Reg. 40,123 (June 21, 2023).
4 TD 9975, 88 Fed. Reg. 40,086 (June 21, 2023).
5 Treas. Reg. §1.48D-6(d)(5).
6 Section 48D(d)(6)(B); Treas. Reg. § 1.48D-6(d)(6)(i).
