Regulations address direct payment of Section 48D tax credit

In detail

Background

Under Section 48D(d), an eligible taxpayer may elect to treat the Section 48D credit as a direct payment. A direct payment is reflected on a federal income tax return as a payment against tax and reduces the tax due. Accordingly, the credit is available without regard to tax liability, similar to a refundable credit. To prevent receipt of a double benefit, the amount of the credit is reduced to zero and deemed to have been allowed in the tax year of the direct payment.

A partnership or S corporation must make the direct payment election for property held by the entity. No election is allowed to a partner or shareholder. To prevent a double benefit, the credit is reduced to zero before determining a partner’s distributive share or S corporation shareholder’s pro rata share of the underlying credit. The direct payment is made to the partnership or S corporation and is treated as tax-exempt income for purposes of Sections 705 and 1366. A partner’s distributive share of the tax-exempt income is based on the partner’s distributive share of the applicable credit.

The Section 48D direct payment election applies in mirror code possessions (the US Virgin Islands, Guam, and the Commonwealth of the Northern Marianas) only if the possession elects to apply the direct payment provisions.

A taxpayer must elect direct payment by the extended due date of the taxpayer’s federal income tax return. The election is irrevocable and applies to a taxpayer’s full Section 48D credit for that tax year. The Section 48D credit may not be transferred.

The excess of a direct payment over the allowable credit is subject to tax plus 20% of the excess, unless a taxpayer can demonstrate reasonable cause.

The Section 48D credit is an investment tax credit to which the basis reduction rules of Section 50(a) and the recapture rules of Section 50(c) apply. Similar rules apply to direct payments of the credit.

Treasury may condition direct payments on compliance with registration and information reporting requirements.

Proposed regulations

Direct payment computation

Section 48D is included in the Section 38 general business credit, which may be limited by tentative minimum tax and carried back or carried forward to other tax years. The proposed regulations provide detailed rules for taxpayers to take into account general business credit carryforwards in computing the amount of a direct payment to prevent receipt of a double benefit. The full amount of the Section 48D 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.

Because Section 38 applies at the partner or shareholder level, a partnership or S corporation computes the amount of a Section 48D credit as if it had not elected direct payment.

Observation:  The proposed regulations provide a five-step process to determine the “net elective payment amount,” which requires applying the Section 38 ordering rules and may affect the treatment of nonrefundable general business credits. Taxpayers may want to consider submitting comments requesting clarification on the consistency of the net elective payment amount computation with allowing taxpayers to “treat the amount of the section 48D credit determined under section 48D(a) as a payment against their Federal income tax liabilities,” as provided in Section 48D(d).

Observation:  Taxpayers may make an annual election under Reg. 1.46-5 to claim a portion of their investment tax credit for qualified progress expenditures before placing the property in service. The Section 48D proposed regulations published on March 23, 2023, providing substantive rules for the Section 48D credit, provide that a taxpayer may elect to take Section 48D credit for qualified progress expenditures paid after August 9, 2022. The preamble to the proposed regulations requests comments on whether additional guidance related to this election would be helpful. Section 6418 expressly prohibits transfers of qualified progress expenditures (applicable to Section 48, 48C, or 48E); however, neither Section 48D, Section 6417 (on direct payment of energy credits), nor the direct payment proposed regulations under those provisions disqualify qualified progress expenditures from a direct payment election. Accordingly, it appears that qualified progress expenditures paid between August 9 and December 31, 2022, are eligible for direct payment if a valid Reg. 1.46-5 election is made.

Partnerships and S corporations

The proposed regulations provide that a partnership or S corporation may elect a Section 48D direct payment for qualified property held by a disregarded entity the partnership or S corporation owns directly or indirectly.

The proposed regulations provide that a partner’s distributive share of tax-exempt income resulting from direct payment of a Section 48D credit is equal to the partner’s distributive share of its otherwise allocable basis in the qualified property. An upper-tier partnership that is a direct or indirect partner of a partnership that makes a direct payment election and directly or indirectly receives an allocation of tax-exempt income must determine its partners’ distributive shares of the tax-exempt income in proportion to the partners’ distributive shares of the Section 48D credit.

An S corporation shareholder’s pro rata share of tax-exempt income is based 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 Section 48D credit is determined.

Observation:  The preamble to the proposed regulations notes that partnerships or S corporations electing direct payment may choose how to use the amount. Distribution to partners or shareholders is not required.

The proposed regulations treat tax-exempt income resulting from a Section 48D direct payment as received or accrued on the date the qualified property is placed in service.

The proposed regulations clarify that the general business credit under Section 38 and passive activity credits under Section 469, which apply at the partner or shareholder level, do not affect the amount of a direct payment election by a partnership or S corporation. The tax-exempt income is treated as arising from an investment activity and not from the conduct of a trade or business for purposes of the passive activity rules of Section 469 and is not treated as passive income to partners or shareholders.

As an investment tax credit, the Section 49 at-risk rules apply in determining the amount of the Section 48D credit. Because these rules apply at the partner or shareholder level, the proposed regulations require the partnership or S corporation to request information from its partners or shareholders about their nonrecourse financing relating to the qualified property and report information about each partner’s or shareholder’s Section 49 limitation on the entity’s tax return. A change in a partner’s or shareholder’s nonqualified nonrecourse financing after the close of the tax year in which the credit amount is determined is disregarded at the entity level.