Section 45X Proposed Regulations Provide Technical and Practical Guidance Before Year End
On December 14, 2023, the U.S. Department of Treasury (Treasury) and the Internal Revenue Service (IRS) released proposed regulations under section 45X (the Proposed Regulations). One of the cornerstones the Inflation Reduction Act of 2022 (IRA), section 45X provides a tax credit for the production of so-called "eligible components," which include solar and wind energy components, inverters, qualifying battery components, and applicable critical minerals. The centerpiece of the Proposed Regulations is further clarification of items that come within the definition of "eligible components." The Proposed Regulations also provide guidance on determining the amount of the credit and further details on how to make certain elections.
Section 45X(a)(1) provides that a per-unit credit is available for each eligible component that is produced by the taxpayer and, during the taxable year, sold to an unrelated person. The production and sale must occur as part of the taxpayer's trade or business. The amount of the credit varies based on the type of eligible component, as set forth in section 45X(b), with a phase-out beginning for eligible components sold in 2030 and the credit completely expiring for eligible components sold in 2033 or later.
The section 45X credit is one of the few IRA credits that is eligible for a section 6417 "direct pay" election even where the taxpayer is not a qualifying non-profit or governmental entity. Alternatively, taxpayers may claim the section 45X credit as part of the section 38 general business credit, or transfer (sell) the credit to another taxpayer under the provisions of section 6418.1
Technical Specifications of Eligible Components and Credit Calculation
Much of the Proposed Regulations provided clarification on the definition certain eligible components. One example is inverters, which are eligible components that are a critical part of residential and commercial solar power systems. Under the statute, an inverter is defined as "an end product which is suitable to convert direct current electricity from 1 or more solar modules or certified distributed wind energy systems into alternating current electricity." The amount credit for the inverter depends on the "type" of inverter (e.g., microinverter, residential inverter, commercial inverter, utility inverter, or central inverter) and its capacity, measured in an alternating current watt basis.2
Under the statute, there was some question as to whether a direct current optimized inverter system would qualify as an inverter for purposes of section 45X. Such systems are typically housed in small plastic boxes under each solar panel in an array and ensure that each panel in an array is producing the maximum amount of power possible. Direct current optimized inverter systems work in conjunction with the central inverter, which converts the direct current produced by the panels into alternating current that can power a home or business. The Proposed Regulations clarify that, if they meet certain specifications, direct current optimized inverter systems qualify as inverters and therefore eligible components for purposes of section 45X.3
Another area is of clarification is the definition of "electrode active materials." Under the statute, electrode active materials are defined as a "qualifying battery component," and therefore an eligible component.4 The credit for these materials is not a set dollar amount but is equal to 10 percent of the costs incurred by the taxpayer with respect to the production of such materials. The statute defines electrode active materials generally as "cathode materials, anode materials, anode foils, and electrochemically active materials, including solvents, additives, and electrolyte salts that contribute to the electrochemical processes necessary for energy storage."5 In addition to providing additional guidance on the definition of electrode active materials and addressing a potential overlap with another eligible component (applicable critical minerals), the Proposed Regulations also provide that costs incurred for purposes of determining the credit includes costs defined in Treas. Reg. § 1.263A-1(e) that are paid or incurred within the meaning of section 461 for the production of the electrode active materials, but excludes any costs incurred after the production of such materials (e.g., costs to incorporate electrode active materials into a battery component).
Sales and Related Persons
Because section 45X requires that the eligible component be sold to an unrelated person, the Proposed Regulations provide guidance on that issue. For instance, responding to comments submitted, Prop. Treas. Reg. § 1.45X-1(i)(2) provides that in the case of a manufacturer that produces battery cells, incorporates the battery cells into battery modules, integrates the battery modules into an electric vehicles, and then sells the electric vehicles to an unrelated person (e.g., a dealer), the sale to an unrelated person qualifies as a sale of the eligible component (here the battery cells and the battery modules) to an unrelated person for purposes of section 45X.
Under section 45X(a)(3)(B), a taxpayer may make an election to treat a sale of eligible components by such taxpayer to a related person as if made to an unrelated person (the Related Person Election). The catch is that the statute permits the IRS to collect "such information or registration as the Secretary deems necessary for purposes of preventing duplication, fraud, or any improper or excessive amount" of section 45X credit. The Proposed Regulations provide guidance relating to the time and manner of making the election (generally, on the original return) and the information required to be provided for such election (including the names and EINs of all related person(s), a list of all eligible components sold, and the intended purpose of those eligible components).6 Under the Proposed Regulations, a Related Person Election is irrevocable once made.7 An anti-abuse rule will prevent a Related Person Election from being effective in the case of an "improper use" of the eligible component, which is defined as a use that is "wasteful, such as discarding, disposing of, or destroying the eligible component without putting it to a productive use by the related person to which the eligible component is sold."8
The Proposed Regulations come at a time when the section 45X credit has become a tense partisan issue. Senator Ron Wyden (D-OR), current chair of the Senate Finance Committee and who held that position in the previous Congress that enacted the IRA, said that the Proposed Regulations "provided the certainty businesses need to fully unleash and revolutionize job creating investments in American manufacturing for solar, wind, batteries, and critical minerals – which will add up to reduced emissions and a stronger U.S. economy."
The GOP, meanwhile, have made the section 45X credit a centerpiece of its critique of the IRA as wasteful green energy spending. The Republican-controlled House passed the "Limit, Save, Grow Act of 2023" on April 26, 2023, which included a repeal of section 45X paired with an increase in the debt limit.9 Congress ultimately passed, and the president signed into law, a debt limit increase that did not include the repeal of any IRA credits.10 As of yet, we are not aware of any official statement from the House Ways & Means Committee on the Proposed Regulations, or from any Republican members of that committee or their Senate Finance Committee (where they are the minority) in their individual capacity.
One background point that informs the debate: the section 45X credit is turning out to be more expensive than anticipated. The Joint Committee on Taxation's (JCT) 2022 revenue estimate of the provision just before the passage of the IRA was an outlay of $30 billion. By the time of the Limit, Save, Grow Act of 2023, that estimate had increased to $135 billion.
Partisan politics aside, based on JCT estimates 2022 tax returns will claim over $5 billion of section 45X credits. The Proposed Regulations provide helpful guidance, though we expect that they will generate substantial comments from taxpayers, which the Administrative Procedures Act (APA) requires Treasury and the IRS to review and consider in promulgating the final rules.
Effective Date and Reliance
The Proposed Regulations would apply to eligible components for which production is completed and sales occur beginning on January 1, 2023 "and during a taxable year ending on or after [date of publication of the final regulations in the Federal Register.]" In other words, even though the section 45X credit was available with respect to the production and sale of eligible components completed during the 2023 calendar year per the terms of the statute, the Proposed Regulations will not apply to sales during that year, because Treasury and the IRS will not be able to finalize the Proposed Regulations before year-end, as comments are due on February 20, 2024, and a public hearing scheduled for February 22, 2024.
As for section 45X claims for sales in the 2023 calendar year, taxpayers will have to look to Form 7207 and its instructions (last updated in January 2023), though the Proposed Regulations, while not binding, give an excellent understanding of Treasury and the IRS's positions on the issues addressed therein. With that said, it is of course conceivable that the IRS could incorporate aspects of the Proposed Regulations into Form 7207 or its instructions prior to when calendar-year taxpayers file their 2022 income tax returns claiming the section 45X credit.
Significantly, there is no statement in the Proposed Regulations that would give taxpayers the option to rely on them for periods before they are effective. With that said, a taxpayer may cite to Proposed Regulations in the determination of whether there is "substantial authority" for a return position to avoid the section 6662(b)(2) accuracy-related penalty for substantial understatement of income tax.11 Further, the Internal Revenue Manual, which is the IRS document that governs the agency's internal procedures, states that "If there are no final or temporary regulations currently in force addressing a particular matter, but there are proposed regulations on point, the Office of Chief Counsel generally should look to the proposed regulations to determine the office's position on the issue. The Office of Chief Counsel ordinarily should not take any position in litigation or advice that would yield a result that would be harsher to the taxpayer than what the taxpayer would be allowed under the proposed regulations." Where the Proposed Regulations are favorable, this perhaps provides taxpayers some comfort, though it should be cautioned that the Internal Revenue Manual does not create any substantive rights in taxpayers. See, e.g., Groder v. United States, 816 F.2d 139, 142 (4th Cir. 1987) (citations omitted). Ultimately each case will be different and the taxpayers will have to consider their facts and circumstances carefully when applying the Proposed Regulations to their facts prior to the effective date of final regulations.
Miller & Chevalier can advise on any issues with the Proposed Regulations, or on participating in the comment process and public hearing. For more information, please contact:
3Prop. Treas. Reg. § 1.45X-3(d)(5)(ii)(B).
6Prop. Treas. Reg. § 1.45X-2(d)(2).
7Prop. Treas. Reg. § 1.45X-2(d)(3)(i).
8Prop. Treas. Reg. § 1.45X-2(d)(4)(ii).
9H.R. 2811, § 237, 4001.
10Fiscal Responsibility Act of 2023, Pub. L. 118-5.
11Treas. Reg. § 1.6662-4(d)(3)(iii).
The information contained in this communication is not intended as legal advice or as an opinion on specific facts. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information, please contact one of the senders or your existing Miller & Chevalier lawyer contact. The invitation to contact the firm and its lawyers is not to be construed as a solicitation for legal work. Any new lawyer-client relationship will be confirmed in writing.
This, and related communications, are protected by copyright laws and treaties. You may make a single copy for personal use. You may make copies for others, but not for commercial purposes. If you give a copy to anyone else, it must be in its original, unmodified form, and must include all attributions of authorship, copyright notices, and republication notices. Except as described above, it is unlawful to copy, republish, redistribute, and/or alter this presentation without prior written consent of the copyright holder.