Navigating the Section 45X Maze in the Inflation Reduction Act

Featured Topics:

• Guidance on the “Produced by the Taxpayer Requirement”
• Guidance on the Domestic Production Rule
• Production Costs Incurred for Critical Minerals and Electrode Active Materials
• Flexibility in Contract Manufacturing Situations
• Detailed Rules on Transactions Between Related Parties

The Department of the Treasury and the Internal Revenue Service (IRS) have recently released proposed regulations to guide the manufacturing tax credit requirements under Section 45X of the Internal Revenue Code (IRC). These regulations, released on December 14, 2023, aim to clarify the rules taxpayers must satisfy to qualify for the Section 45X tax credit.

Section 45X, added to the IRC on August 16, 2022, by the Inflation Reduction Act of 2022 (IRA), offers a tax credit for the production and sale of specific eligible components, including solar and wind energy components, inverters, qualifying battery components, and applicable critical minerals.

The Proposed Regulations offer definitions of eligible components, rules for calculating the credit, and specific recordkeeping and reporting requirements. They also outline rules for the production and sale of eligible components to unrelated and related entities. Additionally, the regulations include provisions related to treating sales to related persons as made to unrelated persons.

The Proposed Regulations provide comprehensive and detailed guidance on various topics applicable to different types of eligible property. While it’s beyond the scope of this article to give a complete summary, here are some notable highlights:

Guidance on the “Produced by the Taxpayer Requirement”

To claim the Section 45X tax credit, a taxpayer must be the producer of the eligible component. The Proposed Regulations clarify that the taxpayer claiming the credit must perform the production activities that bring about a substantial transformation, resulting in the suitable component and the sale of such component. Activities such as partial transformation, minor assembly, or superficial modification would not qualify as “produced by the taxpayer.”

Guidance on the Domestic Production Rule

The Proposed Regulations state that the production of eligible components must be within the United States or a United States territory. Elements, materials, and subcomponents used to make suitable components are not subject to domestic production rules. Additionally, it is permissible to recycle elements, materials, and subcomponents used in the production instead of creating new ones.

Production Costs Incurred for Critical Minerals and Electrode Active Materials

The tax credits available for critical minerals and electrode active materials equal 10% of the costs incurred by the taxpayer for their production. The Proposed Regulations outline that calculation should include capitalized costs under Section 263A. However, production costs do not include expenses related to the extraction or acquisition of raw materials. While this exclusion reduces the overall credit calculation, it aims to prevent double-counting of costs and mitigate the risk of fraud, waste, and abuse. The Treasury Department and the IRS are open to including raw materials costs in the calculation if proven to be workable, and they invite comments on this issue.

Flexibility in Contract Manufacturing Situations

The Proposed Regulations offer flexibility in contract manufacturing arrangements. Under certain circumstances, parties to such agreements can agree on which party will claim the Section 45X credit for eligible components produced subject to the contract.

Detailed Rules on Transactions Between Related Parties

The Section 45X tax credit benefits manufacturers from their eligible component production. The Proposed Regulations outlined above offer much-needed clarity for taxpayers seeking to determine eligibility and make informed decisions. However, some areas still require further resolution, such as excluding raw materials costs for crucial minerals. Interested parties can comment on the Proposed Regulations by the February 13, 2024 deadline.

MBE CPAs commit to supporting individuals and businesses in navigating complex accounting and tax regulations. If you have any questions or require assistance understanding and implementing the Section 45X tax credit guidelines, our advisors are here to help. Together, we can leverage these opportunities for growth and collective success.

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