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Understanding the Section 45X tax credit for manufacturers

September 18, 2023 Article 10 min read
Stephen Eckert Dana Hullinger Donny Lucaj Josh Bemis
Section 45X, established with the Inflation Reduction Act, is a tax credit for businesses that manufacture and sell energy components. Wondering how to qualify, what qualifying energy components are, or how to calculate and claim the tax incentive? Read more.
Two manufacturers working on a new machine.The Inflation Reduction Act of 2022 (IRA) established a collection of interrelated tax credits and incentives supporting domestic clean and renewable energy production. A crucial aspect of that legislation — the Advanced Manufacturing Production Credit under Section 45X — supports the domestic production of equipment and components (solar, wind, batteries, and inverters) and critical minerals. Importantly, this credit incentivizes the manufacturing of equipment required by those seeking to take advantage of many other credits included in the IRA. Thus, the Section 45X credit is the linchpin for the achievement of numerous goals of that legislation. Our tax professionals evaluate the technical details of this credit and describe the paths available for businesses to benefit.

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Section 45X as the catalyst for other IRA credits

The IRA created or modified more than 20 tax credits and incentives with a combination of current and future effective dates. The Section 45X credit directly supports the supply chain for property qualifying for other credits, including:

  • Producing electricity from wind and solar energy; energy storage. Taxpayers placing wind and solar equipment in service over the next decade will be eligible for either investment tax credits or production tax credits related to the production of electricity. Two credits, under Section 45 and Section 48, were modified by the IRA and are currently applicable. Two new credits, under Section 45Y and Section 48E, that are largely similar to the existing rules will take effect for facilities for which construction begins after Dec. 31, 2024. Wind and solar technologies are widely applicable to businesses and organizations, but the investment credits can also extend to energy storage technologies (e.g., batteries). Importantly, all of these credits may be increased if the equipment installed is produced in the United States.
  • Energy production and storage at home. Similar to the business-related credits discussed above, the IRA expanded the credit under Section 25D related to residential clean energy property. Qualifying property includes solar electric property, small wind energy property, and battery storage technology.
  • Production and adoption of electric vehicles (EVs). The IRA modified the existing Section 30D credit for the purchase of new EVs or fuel cell vehicles (FCVs) and created a new Section 45W credit for businesses acquiring new electric vehicles. Battery production that qualifies under Section 45X will support the broader production of EVs. This, in turn, is expected to increase the availability of EVs for taxpayers who wish to qualify under Section 30D and Section 45W.

The IRA created or modified more than 20 tax credits and incentives with a combination of current and future effective dates.

How to qualify for Section 45X: Components, production, and sales

The following elements are the keys to qualification under Section 45X:

  • Eligible components. The statutory text outlines five categories of eligible components: (1) solar energy components, (2) wind energy components, (3) inverters, (4) qualifying battery components, and (5) applicable critical minerals. The statute goes on to describe a long list of subcategories, which are described in greater detail below. Questions remain as to whether certain types of property will fall within those definitions. However, as a threshold matter, the Section 45X credit is only available with respect to the components specifically identified in the text.
  • Production in the United States. The production of eligible components must occur within the United States or a possession of the United States. Unfortunately, the statute doesn’t include any clarification of what’s meant by the term “production,” so further guidance might be necessary. The detailed definition of a possession, under Section 638, extends to include the seabed and subsoil of those submarine areas, which are adjacent to the territorial waters of the United States and over which the United States has exclusive rights, in accordance with international law, with respect to the exploration and exploitation of natural resources. The primary relevance of the “possession” reference here would appear to be for offshore wind installations.
  • Sale to an unrelated person. The general rule is that the property produced by the taxpayer must also be sold to an unrelated person. For this purpose, relatedness is tested under the Section 52(b) rule defining whether persons are treated as a single employer. That rule is widely referenced by other portions of the tax code, so determinations about taxpayer relatedness will typically already exist. A special rule is provided for taxpayers who assemble an otherwise eligible component into another eligible component that’s then sold to an unrelated party. This relaxation rule treats the assembly/integration of the subcomponent as a sale to a related party.
  • Trade or business. The production and sale of eligible components must be part of the taxpayer’s trade or business. Many of the tax credits included in the IRA don’t require a trade or business (e.g., they can be claimed by tax-exempts, governments, and individuals). However, Section 45X specifically requires there to be a trade or business.
  • Timing of production and sales. Eligible components must be both produced and sold after Dec. 31, 2022, to qualify for Section 45X. The credit will begin to phase out by 25% per year for components sold after Dec. 31, 2029. Thus, the credit amount is reduced to 75% for components sold in 2030, 50% in 2031, and 25% in 2032. Notably, however, the credit for the production of critical minerals will not phase out over time.

The credit will begin to phase out by 25% per year for components sold after Dec. 31, 2029.

What are qualifying energy components under Section 45X?

Detailed definitions are included in this document, but below are the initial categories of qualifying components and subcomponents:

  • Solar energy components. The definition of solar energy components is generally inclusive of both solar panels (photovoltaic cells) as well as the supporting infrastructure. Thus, the definition includes solar modules, photovoltaic cells, photovoltaic wafers, solar grade polysilicon, torque tubes or structural fasteners, and polymeric backsheets.
  • Wind energy components. Similarly, the wind energy component definition extends to supporting infrastructure. Specifically, eligible components include blades, nacelles, towers, offshore wind foundations (both fixed and floating platforms), and related offshore wind vessels. The expansive definition of the United States noted above may be read together with the component definitions to encompass construction of offshore wind power systems in addition to those located on land within the United States.
  • Inverters. Section 45X applies to several types of inverters that support solar and wind energy. Specifically, the core definition of an inverter describes an end product that’s suitable to convert direct current electricity from one or more solar modules or certified distributed wind energy systems into alternating current electricity. Going further, six subcategories of inverters are described, including central inverters, commercial inverters, distributed wind inverters, microinverters, residential inverters, and utility inverters.
  • Battery components. Three types of battery components are eligible under Section 45X: electrode active materials, battery cells, and battery modules. The associated definitions are specific and don’t appear to extend to supporting components on their own. This contrasts with the wind and solar categories, which include structural elements to which the operative components are fixed. Thus, Section 45X is available for the production of cells and modules but doesn’t appear to be available for battery cases or connecting equipment.
  • Applicable critical minerals. Many minerals are vital to the operation of modern technologies. Such needs also extend to the many technologies that are promoted by the IRA. Accordingly, Section 45X may be claimed with respect to the production of 50 critical minerals.

This list of eligible components is both long and specific, so the details really do matter.

How do I calculate and claim the Section 45X tax credit?

Section 45X is a production credit, so it’s ultimately calculated based on the amount of eligible components produced during the tax year. Several different types of calculations are provided given the variety of components and production methods. Specific details for each component and subcomponent are included in this table. However, in summary form, there are three core methods of calculation:

  • Value ($) per component size or weight. The credit for five of the solar energy subcomponents is calculated based on a dollar value multiplied by the size (square meter) or weight (kilogram) of such component. Substantiating the credit in this context will likely require detailed records about production and testing to verify weights and size.
  • Value ($) per electric capacity. In many other cases, the credit is calculated based on a dollar value multiplied by the total capacity of the component measured in watts.
  • Percentage of the cost of production. Finally, the credit for other components, especially critical minerals, is calculated as 10% of the costs incurred to produce such components. The statute doesn’t clarify what’s properly includible in costs of production, so further guidance will be required.

Section 45X is a production credit, so it’s ultimately calculated based on the amount of eligible components produced during the tax year.

Businesses generating the Section 45X credit will report such amounts with their federal income tax return. However, there are three distinct paths for such businesses to realize the cash benefit of this credit:

  • Default rule. Section 38 general business credit. Businesses may utilize this credit under the general business credit rules of Section 38 either directly, in the case of a C corporation, or indirectly by the business owners, in the case of a partnership or S corporation. Credits that exceed current tax liabilities will carry forward to future years.
  • Sale of the credit. Businesses may also sell Section 45X credits in exchange for cash payments pursuant to new rules under Section 6418. This option is particularly useful where Section 45X credits are expected to exceed tax liabilities currently and in the near future.
  • Tax refunds for five years. The direct pay feature under Section 6417 is typically not available for businesses and other taxable entities. However, it’s available with respect to Section 45X for a period of five years. Businesses choosing this option will make an election and then receive tax refunds equal to the credit amount.

Initial guidance related to credit sales and direct pay options has been released, but further guidance and forms will be forthcoming.

What’s the catch with Section 45X? Overlap, open questions, and documentation

The Section 45X credit provides a great tax opportunity for qualifying businesses. However, there are several points to keep in mind related to qualification and planning.

  • Credit overlap. The first consideration is potential disqualification due to the application of the Section 48C Qualifying Advanced Energy Project Credit. That’s an investment credit, which was modified and expanded by the IRA, for taxpayers who place in service new equipment as part of a qualifying facility. For purposes of Section 45X, the eligible components described above exclude any components manufactured at a facility that receives credits under Section 48C after enactment of the IRA. While Section 48C is a tax credit program, it requires completion of a multistep application process and the receipt of an allocation of credits by the Department of Energy. Thus, businesses will have a choice to either pursue the Section 48C credit for the installation of new equipment or claim Section 45X based on the production of components at a facility.
  • Questions and guidance. The statutory text of Section 45X is very detailed, but interpretational questions abound, including basic questions regarding the definition of eligible components. They also include deeper questions about what it means to be considered the producer of components, especially in contract manufacturing arrangements. These questions, among others, are expected to be addressed in forthcoming guidance from the IRS. In the interim, businesses and their advisors will need to evaluate the technical bases for positions based on existing authorities. It will be important to watch for additional guidance since future regulations may take different approaches to particular topics.
  • Documentation. The IRA includes many attractive tax opportunities for businesses and organizations. That upside benefit comes with the cost of increased scrutiny in the future. The initial form of scrutiny comes from the IRS and the potential for future audits. A second form of scrutiny comes from potential buyers of Section 45X credits that are sold by a manufacturer pursuant to Section 6418. In either case, businesses should carefully examine their Section 45X tax positions, document their production and positions, and maintain appropriate records moving forward.

The IRA includes many attractive tax opportunities for businesses and organizations. That upside benefit comes with the cost of increased scrutiny in the future.

Have additional questions on how IRA tax credits, incentives, and monetization options could impact your organization? Explore more from our tax leaders as they track the latest developments.

Access the eligible components detailed document

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