Final Regulations Issued Regarding Section 45X Advanced Manufacturing Production Tax Credit
On October 28, 2024, the Internal Revenue Service (the “IRS”) and the Department of the Treasury (“Treasury”) published final regulations (the “final regulations”) regarding the Advanced Manufacturing Production Credit under section 45X (the “45X Credit”) of the Internal Revenue Code. The 45X Credit, established by the Inflation Reduction Act of 2022, is effective for components produced and sold after December 2022 but, for components other than critical minerals, will phase out starting in 2030 and terminate completely by 2033. The 45X Credit is designed to strengthen U.S. energy security by incentivizing the onshoring of production of key clean energy components and critical minerals. In December 2023, the IRS and Treasury released proposed and temporary regulations under section 45X, which we discussed here.
The 45X Credit is a production tax credit based on the amount of the components produced during the tax year. The calculation of the credit varies with the specific components produced and the production method utilized. A taxpayer becomes eligible to claim the 45X Credit by producing and selling eligible components. However, the eligible components must be produced by the taxpayer in the United States and sold to an unrelated party. Eligible components for the 45X Credit are organized into the following five categories: solar energy components, wind energy components, inverters, battery components (including electrode active materials, battery cells and battery modules) and critical minerals.
The final regulations apply to tax years ending on or after October 28, 2024, although taxpayers may choose to apply the regulations to earlier periods. In general, the final regulations adopt the proposed regulations with the following key changes:
- for the calculation of the credit for production of electrode active materials and critical minerals, which is based on the costs of production, permitting the inclusion of extraction costs and certain material costs if certain requirements are met,
- simplifying the rules and examples governing the interaction between the 45X Credit and the qualifying advanced energy project credit under section 48C, and
- clarifying that certain eligible components are not subject to the domestic production rule.
Section 1.45X-1: General Rules and Definitions
Section 1.45X-1 provides general rules applicable to the section 45X Credit, including the definition of the term “produced by the taxpayer.”
The amount of the 45X Credit for applicable critical minerals and electrode active materials is 10% of the costs incurred by the taxpayer with respect to their production. Many commenters had suggested that taxpayers be allowed to include direct and indirect materials costs, including costs related to extraction in the United States or a U.S. territory (which were excluded under the proposed regulations), in production costs for this purpose. The final regulations allow the inclusion of these costs in production costs if certain conditions are met (including extensive substantiation requirements), but only if those direct or indirect material costs do not relate to the purchase of materials that are an eligible component at the time of the acquisition (such as an electrode active material or applicable critical mineral). Additionally, the extraction costs must be incurred by the taxpayer that claims the section 45X Credit with respect to the relevant applicable critical mineral or electrode active material. The final regulations include two examples illustrating the revised production costs rule. The final regulations also include substantiation requirements for taxpayers claiming a 45X Credit for critical minerals or electrode active materials.
Simplification of 45X and 48C Interaction Guidance
The final regulations simplified the rules and examples pertaining to the interaction of section 45X and section 48C (i.e., the investment credit for certain “qualifying advanced energy projects”). The final regulations make clear that the general rule is that property that would otherwise qualify as an eligible component (“otherwise qualified property”) for purposes of section 45X is only an eligible component if the property is produced at a section 45X facility, and no part of that section 45X facility is also a section 48C facility.
Furthermore, the definition of “section 45X facility” was revised so that it includes only the independently functioning tangible property used by the taxpayer that is necessary to be considered the producer of the otherwise qualified property. It is therefore possible that the same taxpayer could receive a section 48C credit on equipment used to produce a subcomponent (or like property) and a 45X Credit on the production of an eligible component that incorporates such subcomponent.
Produced by the Taxpayer
The final regulations generally adopt the proposed definition of “produced by the taxpayer,” with one exception. Several commenters had requested that the final regulations specifically state that taxpayers may produce eligible components using recycled materials. In response thereto, the final regulations clarify that secondary production (i.e., producing an eligible component using recycled materials) qualifies along with primary production. Although the regulations sanction secondary production, the preamble to the final regulations indicates that recycling is unlikely to be considered production in the case of critical minerals, rejecting a commenter’s request that the recycling of aluminum transformer wire be considered secondary aluminum production.
Furthermore, the proposed regulations had distinguished production from “mere assembly.” Commenters had suggested that certain production of solar modules or battery modules using battery cells, which are produced primarily by assembling other components, would not qualify under that language. In response to these concerns, the final regulations replaced each instance of “mere assembly” in the proposed regulations with “minor assembly.”
While section 45X specifically requires domestic production of an eligible component for credit eligibility, it is silent regarding the location of production or sourcing of constituent elements, materials, and subcomponents. In keeping with the text of section 45X and its legislative history, the final regulations declined to adopt any domestic production requirement for such elements, materials, or subcomponents.
Additionally, the preamble to the final regulations confirms that eligible components that are constituent elements, materials, or subcomponents of another eligible component are not subject to the domestic production rule, although the credit would not be available for production of the component that is not domestically produced. Furthermore, raw materials and intermediate productions generally constitute constituent elements, materials, or subcomponents, and are also not subject to the domestic production rule.
Sale of Integrated Components
For purposes of the 45X Credit, a person can be treated as having sold an eligible component to an unrelated person if such component is integrated, incorporated, or assembled into another eligible component which is sold to an unrelated person. The preamble to the final regulations clarifies that this provision only provides for deemed sale treatment and not deemed production: a taxpayer must produce (rather than merely purchase or acquire) an eligible component that is integrated, incorporated, or assembled into another eligible component that is then sold to an unrelated person in order for the deemed sale rule to apply.
Section 1.45X-2: Sales to Unrelated Persons
Section 45X permits a taxpayer to elect to treat a sale of eligible components to a related person as if the sale had been to an unrelated person. Section 1.45X-2 provides operating rules regarding the form and manner of making such an election, which largely correspond to the rules in the proposed regulations.
Section 1.45X-3: Eligible Components, Calculation, and Substantiation Rules
Section 1.45X-3 provides definitions and credit amounts for certain eligible components (i.e., solar energy components, wind energy components, inverters, and qualifying battery components) as well as the phase-out rules.
Solar Components
The final regulations generally adopt the proposed regulations with respect to solar components with some clarifications. The rules clarify that the definition of polymeric backsheet is limited to a sheet on the back of solar modules composed, at least in part, of a polymer. Many commenters had requested that the definitions of solar components such as solar trackers, torque tubes and structural fasteners be revised to allow certain additional components to qualify, such as bearings, arms, and brackets. Treasury declined to make these requested revisions in the final regulations on the basis that it “does not have the authority to expand the definition.”
DC Optimized Inverter Systems
The final regulations provide that in order for a multi-module inverter to qualify as a microinverter, the taxpayer must produce and sell the inverter and the respective DC optimizers together as a combined end product. The preamble to the final regulations clarifies that the inverter and the DC optimizer do not need to be physically packaged together upon sale and they also do not need to be fully interconnected and assembled at the time of sale.
Batteries Without Cells
The 45X Credit for a battery module is based on the capacity of the battery module. The regulations include rules for determining the capacity of a battery module for this purpose. In the case of thermal and thermochemical battery modules with no battery cells, the final regulations explain that taxpayers must convert the energy storage to a kilowatt-hour basis and provide both the methodology and testing regarding this conversion. The kilowatt-hour conversion cannot exceed the direct conversion of the total nameplate capacity of the thermal battery module to kilowatt-hours (i.e., the capacity that is sold to the consumer).
Section 1.45X-4: Applicable Critical Minerals
Section 1.45X-4 provides definitions for applicable critical minerals, and rules regarding the determination of the credit amount.
Waiting on Aluminum
The preamble to the final regulations states that Treasury and the IRS have determined that additional consideration is necessary prior to finalizing the regulations with respect to the definition of aluminum. Commenters submitted many comments regarding the definition of aluminum and the meaning of “commodity-grade aluminum” which the proposed regulations sanctioned as an eligible critical mineral but limited to primary, and not secondary, production. As a result, the section of the regulations that addresses the definition of aluminum is reserved and remains proposed, not final. Although the official comment period for the proposed regulations has closed, the submission of additional comments at this time could assist Treasury and the IRS in their consideration of these issues.
We will continue to monitor the Inflation Reduction Act guidance initiatives from the IRS and Treasury and will provide further updates as guidance is released. In the meantime, Baker Botts would be pleased to assist you in your analysis of the Inflation Reduction Act and other clean energy tax incentive matters.
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