Category: Tax

Whistleblower Tax Fraud Lawsuit Against Bitcoin Billionaire Settles for $40 Million

MicroStrategy’s founder is alleged to have falsified tax documents for ten years. The settlement resolves the first whistleblower lawsuit filed under 2021 amendments to the DC False Claims Act.

Key Takeaways
On June 3, the District of Columbia Office of the Attorney General announced the $40 million settlement with Michael Saylor
It is the largest income tax recovery in D.C. history
The settlement, which resolves a qui tam lawsuit filed under the DC False Claims Act, underscores the power of whistleblowers in combatting tax fraud
On June 3, the District of Columbia Office of the Attorney General (OAG) made a landmark announcement. The billionaire founder of MicroStrategy Incorporated, Michael Saylor, settled a tax fraud lawsuit for a staggering $40 million. This case, stemming from a qui tam whistleblower suit filed under the District’s False Claims Act, marks a significant milestone in the fight against tax fraud. The OAG declared this as the largest income tax recovery in D.C. history, underscoring the importance of this case.

The DC False Claims Act
This settlement is not just a victory for the District but also a testament to the power of whistleblowers. Under the 2021 extension of the D.C. False Claims Act, individuals have the power to file qui tam suits against large companies and suspected tax evaders. The 2021 amendments even offer monetary awards to those who report tax cheats. This settlement, the first settlement under these amendments, serves to put would-be tax cheats on notice.

As the District of Columbia expands its arsenal against tax fraud, other states should take note. The DC False Claims Act, now covering tax fraud, has become a powerful tool in the fight against financial misconduct. With the District joining the ranks of Delaware, Florida, Illinois, Indiana, Nevada, New York, and Rhode Island as states where false claims suits may be brought based on tax fraud claims, the fight against tax cheats looks promising.

The Case Against Saylor
In 2021, unnamed whistleblowers filed a lawsuit against Saylor, alleging that he had defrauded the District and failed to pay income taxes from 2014 to 2020. The OAG independently investigated these claims and filed a separate complaint against Saylor. The District’s lawsuit alleged that Saylor claimed to be a resident of Florida and Virginia to avoid paying over $25 million in income taxes. Another suit was filed against MicroStrategy, claiming it falsified records and statements that facilitated Saylor’s tax avoidance scheme.

The District’s allegations against Saylor paint a picture of a lavish lifestyle. Saylor is accused of unlawfully withholding tens of millions in tax revenue by claiming to live in a lower tax jurisdiction to avoid paying D.C. income taxes. The OAG’s investigation revealed that Saylor owned a 7,000-square-foot luxury penthouse overlooking the Potomac Waterfront and docked multiple yachts in the Washington Harbor. He purchased three luxury condominium units at 3030 K Street NW to combine into his current residence and a penthouse unit at the Eden Condominiums, 2360 Champlain St. NW. The Attorney General compiled several posts from Saylor’s Facebook, in which he boasted about the view from his D.C. residence.

Whistleblower Tax Fraud Lawsuit Against Bitcoin Billionaire Settles For $40 Million

Furthermore, the OAG found evidence that Saylor purchased a house in Miami Beach, obtained a Florida driver’s license, registered to vote in Florida, and falsely listed his residence on MicroStrategy W-2 forms. Attorney General Brian L. Schwalb stated, “Saylor openly bragged about his tax-evasion scheme, encouraging his friends to follow his example and contending that anyone who paid taxes to the District was stupid.”

The lawsuits allege that records from Saylor’s security detail provide Saylor’s physical location and travel from 2015 to 2020 and show that across six years, Saylor spent 449 days in Florida and 1,397 days in the District. Saylor allegedly directed MicroStrategy employees to aid his scheme to avoid paying District income taxes. The District claims that for the last ten years, MicroStrategy has falsely reported its income tax exemption on Saylor’s wages, claiming he was tax-exempt due to his residential status.

Saylor agreed to pay the District $40 million to resolve the allegations against him and MicroStrategy.

A copy of the settlement can be found here.

Copyright Kohn, Kohn & Colapinto, LLP 2024. All Rights Reserved.

by: Whistleblower Law at Kohn Kohn Colapinto of Kohn, Kohn & Colapinto

For more on Whistleblowers, visit the NLR Criminal Law / Business Crimes section.

Treasury Proposes Clean Electricity Tax Guidance

On May 29, 2024, the Internal Revenue Service (IRS) and the Treasury Department released the pre-publication version of proposed guidance to implement “technology-neutral” clean electricity tax credits, including deeming certain technologies as per se zero-emitting and outlining potential methodologies for determining how other technologies—namely those involving combustion or gasification—could qualify as zero-emitting based on a lifecycle emissions analysis (LCA). The Clean Electricity Production Credit (45Y) and Clean Electricity Investment Credit (48E) were enacted in the Inflation Reduction Act (IRA) of 2022 and replace the current production and investment tax credits that are explicitly tied to certain types of renewable energy technologies.

Stakeholders have cited the 45Y and 48E credits as the most important driver of greenhouse gas (GHG) emission cuts possible from the IRA over the next decade. One study by the Rhodium Group found that the credits could reduce the power sector’s GHG emissions by up to 73 percent by 2035. The tax credits aim to give qualifying facilities the ability to develop technologies over time as they reduce emissions and offer longer-term certainty for investors and developers of clean energy projects. This proposed rule, when finalized, will be a critical driver for developers and companies allocating resources among different projects and investments.

The proposed guidance is scheduled to be published June 3, 2024 in the Federal Register, launching a 60-day comment period. A public hearing will be held August 12-13, 2024.

Proposed Guidance Details

Starting in Fiscal Year (FY) 2025 for projects placed into service after Dec. 31, 2024, 45Y provides taxpayers with a base credit of 0.3 cents (1.5 cents, if the project meets prevailing wage and apprenticeship requirements) per kilowatt of electricity produced and sold or stored at facilities with zero or negative GHG emissions. (These per kilowatt credit values are adjusted for inflation using 1990 as the base year.) Under 48E, taxpayers would receive a 6 percent base credit (30 percent, if the project meets prevailing wage and apprenticeship requirements) on qualified investment in a qualified facility for the year the project is placed in service. Both credits include bonus amounts for projects located in historical energy communities, low-income communities, or on tribal land; for meeting certain domestic manufacturing requirements; or for being part of a low-income residential building or economic benefit project. Direct pay and transferability are options for both credits. Both credits are in effect until 2032, when they become subject to a three-year phaseout.

Technologies recognized as per se zero-emissions in the guidance are wind, solar, hydropower, marine and hydrokinetic, nuclear fission and fusion, geothermal, and certain types of waste energy recovery property (WERP). The guidance also outlines how energy storage can qualify, including by proposing definitions of electricity, thermal, and hydrogen storage property.

A principal debate in the proposal is how to determine, using an LCA, whether certain combustion and gasification (C&G) technologies can qualify as zero-emitting.

The guidance includes a set of definitions and interpretations critical to implementation of the tax credits. For example, the proposed C&G definition includes a hydrogen fuel cell if it “produced electricity using hydrogen that was produced by an electrolyzer powered, in whole or in part, by electricity from the grid because some of the electricity from the grid was produced through combustion or gasification.” The proposed C&G definition would also include both biogas- and biomass-based power, but eligibility depends on the LCA results; for biomass, the guidance seeks comment on what spatial and temporal scales should apply and how land use impacts the LCA.

The guidance states that the IRS intends to establish rules for qualifying facilities that generate electricity from biogas, renewable natural gas, and fugitive sources of methane. The guidance says that Treasury and the IRS “anticipate” requiring that, for such facilities, the gas must originate from the “first productive use of the relevant methane.”

The proposed C&G definition allows for carbon capture and storage (CCS) that meets LCA requirements. However, the IRA does not allow credits to go toward facilities already using certain other credits, including the relatively more generous section 45Q credits for CCS.

Specifically, there are seven other credits that cannot be used in combination with a 45Y or 48E credit: 45 (existing clean electricity production credit); 45J (advanced nuclear electricity credit); 45Q (CCS); 45U (zero-emission nuclear credit); 48 (existing clean electricity investment credit); for 45Y, 48E (new clean electricity production credit); and for 48E, 45Y (new clean electricity investment credit).

The guidance proposes beginning and ending boundaries for LCAs, stating “the starting boundaries would include the processes necessary to produce and collect or extract the raw materials used to produce electricity from combustion or gasification technologies, including those used as energy inputs to electricity production. This includes the emissions effects of relevant land management activities or changes related to or associated with feedstock production.” Another topic in the guidance is the use of carbon offsets to reach net-zero qualification status, with the proposal seeking comment on boundaries: “offsets and offsetting activities that are unrelated to the production of electricity by a C&G Facility, including the production and distribution of any input fuel, may not be taken into account” by an LCA. The guidance also includes rules on qualified interconnection costs in the basis of a low-output associated qualified facility, the expansion of a facility and incremental production, and the retrofitting of an existing facility.

The guidance describes the role of the Department of Energy (DOE) in implementing the tax credits. Any future changes to technologies designated as zero-emitting or to the LCA models must be completed with analyses prepared by DOE’s national labs along with other technical experts. Facilities seeking eligibility may also request a “provisional emissions rate,” which DOE would administer with the national labs and experts “as appropriate.”

Next Steps

As noted above, the proposed guidance is scheduled to be published June 3, 2024 in the Federal Register, launching a 60-day comment period for interested parties to make arguments and provide evidence for changes they would like to see before the rule becomes final. A public hearing will be held August 12-13, 2024. The Treasury Department in consultation with interagency experts plans to carefully review comments and continue to evaluate how other types of clean energy technologies, including C&G technologies, may qualify for the clean electricity credits.

© 2024 Van Ness Feldman LLP
For more news on Clean Energy Tax Credits, visit the NLR Environmental, Energy & Resources section.

The Domestic Content Bonus Credit’s Promising New Safe Harbor

On May 16, 2024, the Internal Revenue Service (IRS) published Notice 2024-41 (Notice), which modifies Notice 2023-38 (Prior Notice) by providing a new elective safe harbor (Safe Harbor) that will allow taxpayers to use assumed domestic cost percentages in lieu of percentages derived from manufacturers’ direct cost information to determine eligibility for the domestic content bonus credit (Domestic Content Bonus). The Notice grants a promising reprieve to the Prior Notice’s relatively inflexible (and arguably impracticable) standard on seeking direct cost information from manufacturers, raising novel structuring considerations for energy producers, developers, investors and buyers.

The Notice also expands the list of technologies covered by the Prior Notice (Applicable Projects).

In this article, we share key takeaways from the Notice as they apply to energy producers, developers and investors and provide a brief overview of the Domestic Content Bonus as well as a high-level summary of the Notice’s substantive content.

IN DEPTH

KEY TAKEAWAYS FROM THE NOTICE

The Notice provides a key step forward in eliminating qualification challenges for the Domestic Content Bonus by providing an alternative to the Prior Notice’s stringent requirement of seeking direct cost information from manufacturers. In short, a taxpayer can aggregate the assumed percentages in the Notice that correspond with the US-made manufactured products in its project. If the assumed percentages total is greater than the manufactured product percentage applicable to such project (currently 40%), then the taxpayer is treated as satisfying the manufactured product requirement. Although the Notice promises forthcoming proposed regulations that could amend or override the Notice, this gives taxpayers time to appropriately interpret the latest rules and respond accordingly.

The new guidance’s impact will likely require restructuring to the existing development of energy projects as it relates to the Domestic Content Bonus. Below, we outline some key considerations for energy producers, developers, investors and buyers alike:

  • The Safe Harbor is expected to dramatically increase the availability of the Domestic Content Bonus. The Prior Notice’s challenging cost substantiation requirements left most industry participants on the sidelines. Initial feedback from developers, investors and credit buyers was extremely positive, and we have already seen fulsome renegotiation and speedy agreement between counterparties over domestic content contractual provisions in project documents.
  • While the Safe Harbor eliminates the requirement to seek direct cost information from manufacturers for certain Applicable Projects, a taxpayer’s obligations with respect to substantiation requirements for manufacturers’ US activities is not clear in the Notice. Given the standing federal income tax principles on recordkeeping and substantiation, taxpayers should carefully reconsider positions on diligence and review existing relationships with manufacturers.
  • Although the Notice expressly provides that the Safe Harbor is elective with respect to a specific Applicable Project, it’s unclear whether the Safe Harbor is extended by default to any and all of a taxpayer’s Applicable Projects upon election effect or whether an elective position is required with respect to each Applicable Project. Taxpayers, especially those with multiple Applicable Projects, should consider the various implications resulting from an elective position prior to reliance on the Safe Harbor.
  • For Safe Harbor purposes, the Notice provides a formula for computing a single domestic cost percentage for solar energy property and battery energy storage technologies that are treated as a single energy project (PV+BESS Project), but ambiguity exists as to whether such technologies should be aggregated for other purposes under the investment tax credit.
  • It’s unclear how the calculations would operate for repowered facilities given the assumed domestic cost percentage approach.
  • The Notice limits the Safe Harbor to solar photovoltaic, onshore wind and battery energy storage systems, leaving taxpayers with other types of Applicable Projects stranded with the Prior Notice. For example, the Notice does not cover renewable natural gas or fuel cell. The IRS seeks comments on whether the Safe Harbor should account for other technologies, the criteria and how often the list of technologies should be updated. Affected taxpayers should fully consider the requested comments and provide feedback as necessary.
  • The IRS seeks comments on various issues with respect to taxpayers who have a mix of foreign and domestic manufactured product components (mixed source items). Taxpayers with mixed source items that the Notice attributes as disregarded and entirely foreign sourced (notwithstanding the domestic portion) should take cautionary note and provide feedback as necessary.

BACKGROUND: THE DOMESTIC CONTENT BONUS CREDIT

The Inflation Reduction Act of 2022 spurred the creation of “adder” or “bonus” incentive tax credits. In pertinent part, Applicable Projects could further qualify for an increased credit (i.e., the Domestic Content Bonus) upon satisfaction of the domestic content requirement.

To qualify for the Domestic Content Bonus, taxpayers must meet two requirements. First, steel or iron components of the Applicable Project that are “structural” in nature must be 100% US manufactured (Steel or Iron Requirement). Second, costs associated with “manufactured components” of the Applicable Project must meet the “adjusted percentage” set forth in the Internal Revenue Code (Manufactured Products Requirement). For projects beginning construction before 2025, the adjusted percentage is 40%.

The Prior Notice provided guidance for meeting these requirements. Taxpayers should begin by identifying each “Applicable Project Component” (i.e., any article, material or supply, whether manufactured or unmanufactured, that is directly incorporated into an Applicable Project). Subsequently, taxpayers must determine whether the Applicable Project Component is subject to the Steel or Iron Requirement or the Manufactured Products Requirement.

If the Applicable Project Component is steel or iron, it must be 100% US manufactured with no exception. If the Applicable Project Component is a manufactured product, such component and its “manufactured product components” must be tested as to whether they are US manufactured. If the manufactured product and all its manufactured product components are US manufactured, then the manufacturer’s cost of the manufactured product is included for purposes of satisfying the adjusted percentage. If any of the manufactured product or its manufactured product components are not US manufactured, only the cost to the manufacturer of any US manufactured product components are included.

The core tension lies in sourcing the total costs from the manufacturer of the manufactured product or its manufactured product components. There’s a substantiation requirement on the taxpayer imposed by the Prior Notice, but there’s also a shrine of secrecy from the corresponding manufacturer.

Apparently acknowledging the need for reconciliation, the Notice aims to pave a promising path for covered technologies (i.e., solar, onshore wind and battery storage).

THE MODIFICATIONS: A PROMISING PATH FOR THE DOMESTIC CONTENT BONUS CREDIT

NEW ELECTIVE SAFE HARBOR

Generally

The Safe Harbor allows a taxpayer to elect to assume the domestic percentage costs (assumed cost percentages) for manufactured products. Importantly, the election eliminates the requirement for a taxpayer to source a manufacturer’s direct costs with respect to the taxpayer’s Applicable Project and instead allows for the reliance on the assumed cost percentages. The Notice prohibits any partial Safe Harbor reliance, meaning taxpayers who elect to use the Safe Harbor must apply it in its entirety to the Applicable Project for which the taxpayer makes such election.

The Safe Harbor only applies to the Applicable Projects of solar photovoltaic facilities (solar PV), onshore wind facilities and battery energy storage systems (BESS). Taxpayers with other technologies must continue to comply with the Prior Notice. Notably, the Notice expands Solar PV into four subcategories: Ground-Mount (Tracking), Ground-Mount (Fixed), Rooftop (MLPE) and Rooftop (String), each having differing assumed cost percentages for the respective manufactured product component. Similarly, BESS is expanded into Grid-Scale BESS and Distributed BESS, each with differing assumed cost percentages for the respective manufactured product component.

For solar PV, onshore wind facilities and BESS, the Safe Harbor provides a list via Table 1[1] (Safe Harbor list) that denotes each relevant manufactured product component with its corresponding assumed cost percentage. Each manufactured product component (and steel or iron component) are classified under a relevant Applicable Project Component.

Of note are the disproportionately higher assumed cost percentages of certain listed components within the Safe Harbor list. For solar PV, cells under the PV module carry an assumed cost percentage of 36.9% (Ground-Mount (Tracking)), 49.2% (Ground-Mount (Fixed)), 21.5% (Rooftop (MLPE)) or 30.8% (Rooftop (String)).

For onshore wind facilities, blades and nacelles under wind turbine carry an assumed cost percentage of 31.2% and 47.5%, respectively.

For BESS, under battery pack, Grid-scale BESS cells and Distributed BESS packaging carry an assumed cost percentage of 38.0% and 30.15%, respectively. Accordingly, projects incorporating US manufactured equipment in these categories are likely to meet the Manufactured Products Requirement with little additional spend. Conversely, projects without these components are unlikely to satisfy the threshold.

Mechanics of the Safe Harbor

Reliance on the Safe Harbor is a simple exercise of component selection and subsequent assumed cost percentage addition. Put more specifically, a taxpayer identifies the Applicable Project on the Safe Harbor list and assumes the list of components within (without regard to any components in the taxpayer’s project that are not listed). Then, the taxpayer (i) identifies which of the components within the Safe Harbor list are in their project, (ii) confirms that any steel or iron components on the Safe Harbor list fulfill the Steel or Iron Requirement, and (iii) sums the assumed cost percentages of all identified listed components that are 100% US manufactured to determine whether their Applicable Project meets the relevant adjusted percentage threshold.

The Notice addresses nuances in situations involving mixed 100% US manufactured and 100% foreign manufactured components that are of like-kind, component production costs and treatment for PV+BESS Projects.

The Notice also provides that a taxpayer adjusts for a mix of US manufactured and foreign manufactured components by applying a weighted formula to account for the foreign components.

Consistent with the Prior Notice, the Notice provides that the assumed cost percentage of “production” costs may be summed and included in the domestic cost percentage only if all the manufactured product components of a manufactured product are 100% US manufactured.

Lastly, in accordance with the view that a PV+BESS Project is treated as a single project, the Notice provides that a taxpayer may use a weighted formula to determine a single domestic content percentage for the project.

The numerator is the sum of the (i) aggregated assumed cost percentages of the manufactured product components that constitute the solar PV multiplied by the solar PV nameplate capacity and (ii) aggregated assumed cost percentages of the manufactured product components that constitute BESS multiplied by the BESS nameplate capacity and the “BESS multiplier.” The BESS multiplier converts the BESS nameplate capacity into proportional equivalency (i.e., equivalent units) to the solar PV nameplate capacity. The denominator is the sum of the solar PV nameplate capacity and the BESS nameplate capacity. Divided accordingly, the final fraction constitutes the single domestic content percentage that the taxpayer uses to determine whether its PV+BESS Project meets the relevant manufactured product adjusted percentage threshold.

Additionally, the Notice confirms that taxpayers can ignore any components not included in the Safe Harbor list. Compared with the Prior Notice, this can be a benefit for taxpayers with non-US manufactured products that are not on the Safe Harbor list. Conversely, for taxpayers with US manufactured products that are not on the Safe Harbor list, they lose the benefit of including such costs in the Manufactured Products Requirement. However, this is mostly a benefit because it eliminates any ambiguity surrounding the treatment of components not listed in the Prior Notice.

EXPANSION OF COVERED TECHNOLOGIES

The Notice adds “hydropower facility or pumped hydropower storage facility” to the list of Applicable Projects as a modification to Table 2 in the Prior Notice. The modification is complete with a list of a hydropower facility or pumped hydropower storage facility’s Applicable Project Components that are delineated as either steel or iron components or manufactured products, though no assumed cost percentages are provided. Further, the Prior Notice’s “utility-scale photovoltaic system” is redesignated as “ground-mount and rooftop photovoltaic system.”

CERTIFICATION

To elect to rely on the Safe Harbor, in its domestic content certification statement, a taxpayer must provide a statement that says they are relying on the Safe Harbor. This is submitted with the taxpayer’s tax return.

RELIANCE AND COMMENT PERIOD

Taxpayers may rely on the rules set forth in the Notice and the Prior Notice (as modified by the Notice) for Applicable Projects, the construction of which begins within 90 days after the publication of intended forthcoming proposed regulations.

Comments should be received by July 15, 2024.

CONCLUSION

While this article provides a high-level summary of the substantive content in the Notice, the many potential implications resulting from these developments merit additional attention. We will continue to follow the development of the guidance and provide relevant updates as necessary.

© 2024 McDermott Will & Emery
For more news on IRS Taxpayer Safe Harbor, visit the NLR Tax section.

US Issues Final Regulations on FEOC Exclusions from Clean Vehicle Credit

On May 6, 2024, the U.S. Department of the Treasury (Treasury) and Internal Revenue Service (IRS) published final regulations (Final Regulations) regarding clean vehicle tax credits under Internal Revenue Code sections 25E and 30D established by the Inflation Reduction Act of 2022 (IRA). Among other important guidance, the Treasury regulations finalized its rules on Foreign Entity of Concern (FEOC) restrictions regarding the section 30D tax credit. On the same day, in conjunction with the Treasury final regulations, the U.S. Department of Energy (DOE) published a final interpretive rule (Notification of Final Interpretive Rule) finalizing its guidance for interpreting the statutory definition of FEOC under Section 40207 of the Infrastructure Investment and Jobs Act (IIJA). The Treasury final regulations and the DOE final interpretive rule largely adopted the proposed regulations and interpretive rule on FEOC published by the Treasury and the DOE on December 4, 2023, with some important changes and clarifications.

DOE Final Interpretative Rule on FEOC

The DOE’s final interpretive rule confirms the major elements of the December 2023 proposed interpretive rule and clarifies the definition of “foreign entity of concern” by providing interpretations of the following key terms: “government of a foreign country,” “foreign entity,” “subject to the jurisdiction,” and “owned by, controlled by, or subject to the direction.”

The final rule does not make any changes to its interpretations of “foreign entity” and “subject to the jurisdiction,” but makes clarifying changes to its interpretations of “government of a foreign country” and “owned by, controlled by, or subject to the direction.”

Government of a Foreign Country

The DOE’s final interpretive rule does not change the framework of the definition of “government of a foreign country,” which includes, among other elements, current or former senior political figures of a foreign country and their immediate family members. However, in the specific context of the PRC, DOE makes substantial changes and clarifies that the definition of “senior foreign political figure” now also includes current and former members of the National People’s Congress and Provincial Party Congresses, and current but not former members of local or provincial Chinese People’s Political Consultative Conferences.

Moreover, the final rule further clarifies and broadens when an official will be considered “senior” as follows: “an official should be or have been in a position of substantial authority over policy, operations, or the use of government-owned resources” (emphasis added).

Owned by, Controlled by, or Subject to the Direction

The DOE’s final interpretive rule is largely consistent with the proposed interpretive rule for the interpretations of “owned by, controlled by, or subject to the direction,” but makes some clarifying edits in response to public comments.

  • Control by 25% Interest

The DOE’s final interpretive rule finalizes the 25% control test provided in the proposed interpretive rule and makes further clarifications to the method for calculating the control percentage. The 25% threshold is to apply to each metric (board seats, voting rights, and equity interests) independently, not in combination, and the highest metric is used for the FEOC analysis. For example, if an entity has 20% of its voting rights, 10% of its equity interests, and 15% of its board seats held by the government of a covered nation, the entity would be treated as being 20% controlled by the covered nation government (not combined 45% control).

  • Effective Control by Licensing and Contracting

The DOE’s final interpretive rule finalizes that licensing agreements or other contracts can create a control relationship for FEOC test purposes and has proposed a safe harbor for evaluation of “effective control.” The final interpretive rule provides a list of rights covering five categories that need to be expressly reserved under the safe harbor rule. One requirement is that a non-FEOC needs to retain access to and use of any intellectual property, information, and data critical to production. In response to public comments, the final interpretive rule makes compromise regarding this requirement and provides that the non-FEOC entities need to retain such access and use no longer than “the duration of the contractual relationship.”

Moreover, in the final interpretive rule, the DOE declines to expand the definition of “control” to include foreign entities that receive significant government subsidies, grants, or debt financing from the government of a covered nation.

Treasury Final Regulations on FEOC Restrictions

The Treasury’s final regulations cross-reference the DOE’s FEOC interpretive guidance regarding FEOC definitions. Similar to the DOE’s final interpretive rule, the Treasury’s final regulations generally follow the December 2023 proposed regulations regarding FEOC restrictions and compliance regulations relating to the section 30D clean vehicle tax credit, but have also made certain important modifications and clarifications outlined below:

Allocation-based Accounting Rules

For the FEOC restrictions, the Treasury final regulations make permanent the allocation-based accounting rules for applicable critical minerals contained in battery cells and associated constituent materials.

Due Diligence

The final regulations confirm that to satisfy the due diligence requirement for FEOC compliance, and in addition to the due diligence conducted by the manufacturers meeting the qualification requirements of the regulations (qualified manufacturers) themselves, the qualified manufacturers can also reasonably rely on due diligence and attestations and certifications from suppliers if the qualified manufacturers do not know or have reason to know that such attestations or certifications are incorrect.

Impracticable-to-trace Battery Materials

The final regulations finalize a transition rule, which provides that the FEOC restrictions will not apply to qualified manufacturers as to “impracticable-to-trace battery materials” before 2027. The term “impracticable-to-trace battery materials” replaces the proposed regulations’ reference to “non-traceable battery materials.” Impracticable-to-trace battery materials are defined in the final regulations as specifically identified low-value battery materials that originate from multiple sources and are commingled by suppliers during production processes to a degree that the qualified manufacturers cannot determine the origin of such materials. The final regulations also identify certain battery materials as constituting impracticable-to-trace battery materials. Qualified manufacturers may temporarily exclude impracticable-to-trace battery materials from the required FEOC due diligence and FEOC compliance determinations until January 1, 2027. To take advantage of this transition rule, qualified manufacturers must submit a report during the upfront review process as set forth in the final regulations, demonstrating how they will comply with the FEOC restrictions once the transition rule is no longer in effect.

Traced Qualifying Value Test

The final regulations provide a new test, the “traced qualifying value test,” for OEMs to trace the sourcing of critical minerals and determine the actual value-added percentage for each applicable qualifying critical mineral for each procurement chain.

Exemption for New Qualified Fuel Cell Motor Vehicles

The final regulations also confirm that the FEOC restrictions generally do not apply to new qualified fuel cell motor vehicles (with certain exception) as they do not contain clean vehicle batteries.

Conclusion

Under the final regulations and final interpretive rule, to take advantage of the section 30D tax credit, qualified manufacturers shall conduct FEOC and supply chain analysis and satisfy the due diligence, certification and other requirements. Moreover, for the qualified manufacturers that seek to rely on their battery suppliers’ due diligence and relevant attestations or certifications, they should consider incorporating terms in their contracts with such suppliers that require reporting and tracing assurances regarding battery materials and critical minerals.

The DOE’s final interpretive rule became effective on May 6, 2024. The Treasury’s final regulations will be effective on July 5, 2024.

© 2024 Miller, Canfield, Paddock and Stone PLC
For more news on FEOC Exclusions from Clean Vehicle Credit, visit the NLR Tax section.

Death, Taxes, and Crypto Reporting – The Three Things You Cannot Escape

The IRS released a draft of Form 1099-DA “Digital Asset Proceeds from Broker Transactions” in April which will require anyone defined as a “broker” to report certain information related to the sale of digital assets. The new reporting requirements will be effective for transactions occurring in 2025 and beyond. The release of Form 1099-DA follows a change in the tax law.

In 2021, Congress amended code section 6045 to define “broker” to include any “person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” This is an expansion of the definition of a “broker.” The language ‘any service effectuating transfers of digital assets’ is oftentimes construed by many in the tax practitioner community as a catch-all term, in which the government could use to determine many people involved in digital asset platforms aa “brokers.”

The IRS proposed new regulations in August 2023 to further define and clarify the new reporting requirements. Under the proposed regulations, Form 1099-DA reporting would be required even for noncustodial transactions including facilitative services if the provider is in a “position to know” the identity of the seller and the nature of the transaction giving rise to gross proceeds. With apparently no discernible limits, facilitative services include “services that directly or indirectly effectuate a sale of digital assets.” Position to know means “the ability” to “request” a user’s identifying information and to determine whether a transaction gives rise to gross proceeds. Under these proposed regulations and the expanded definition of “broker,” a significant number of transactions that previously did not require 1099 reporting will now require reporting. There has been pushback against these proposed regulations, but the IRS appears determined to move forward with these additional reporting requirements.

Copyright ©2024 Nelson Mullins Riley & Scarborough LLP
For more news on Taxes and Crypto Reporting, visit the NLR Tax section.

Protect Yourself: Action Steps Following the Largest-Ever IRS Data Breach

On January 29, 2024, Charles E. Littlejohn was sentenced to five years in prison for committing one of the largest heists in the history of the federal government. Littlejohn did not steal gold or cash, but rather, confidential data held by the Internal Revenue Service (IRS) concerning the United States’ wealthiest individuals and families.

Last week, more than four years after Littlejohn committed his crime, the IRS began notifying affected taxpayers that their personal data had been compromised. If you received a notice from the IRS, it means you are a victim of the data breach and should take proactive steps to protect yourself from fraud.

IN DEPTH

Littlejohn’s crime is the largest known data theft in the history of the IRS. He pulled it off while working for the IRS in 2020, using his access to IRS computer systems to illegally copy tax returns (and documents attached to those tax returns) filed by thousands of the wealthiest individuals in the United States and entities in which they have an interest. Upon obtaining these returns, Littlejohn sent them to ProPublica, an online nonprofit newsroom, which published more than 50 stories using the data.

Under federal law, the IRS was required to notify each taxpayer affected by the data breach “as soon as practicable.” However, the IRS did not send notifications to the affected taxpayers until April 12, 2024 – more than four years after the data breach occurred, and months after Littlejohn’s sentencing hearing.

TAKE ACTION

If you received a letter from the IRS (Letter 6613-A) enclosing a copy of the criminal charges against Littlejohn, it means you were a victim of his illegal actions. To protect yourself from this unprecedented breach of the public trust, we recommend the following actions:

  1. Consider Applying for an Identity Protection PIN. A common crime following data theft involves using a taxpayer’s social security number to file fraudulent tax returns requesting large refunds. An Identity Protection PIN (IP PIN) can help protect you from this scheme. After you obtain an IP PIN, criminals cannot file an income tax return under your name without knowing your identification number, which changes annually. Learn more and apply for an IP PIN here.
  2. Request and Review Your Tax Transcript. The IRS maintains a transcript of all your tax-related matters, including filings, payments, refunds, extensions and official notices. Regularly reviewing your tax transcript (e.g., every six to 12 months) can reveal fraudulent activity while there is still time to take remedial action. Request a copy of your tax transcript here. If you have questions about your transcript or need help obtaining it, we are available to assist you.
  3. Obtain Identity Protection Monitoring Services. Applying for an IP PIN and regularly reviewing your tax transcript will help protect you from tax fraud, but it will not protect you from other criminal activities, such as fraudulent loan applications. To protect yourself from these other risks, you should obtain identity protection monitoring services from a reputable provider.
  4. Evaluate Legal Action. Data breach victims should consider taking legal action against Littlejohn, the IRS and anyone else complicit in his wrongdoing. Justifiably, most victims will not want to suffer the cost, aggravation and publicity of litigation, but for those concerned with the public tax system’s integrity, litigation is an option.

In fact, litigation against the IRS is already underway. On December 13, 2022, Kenneth Griffin, the founder and CEO of Citadel, filed a lawsuit against the IRS in the US District Court for the Southern District of Florida after discovering his personal tax information was unlawfully disclosed to ProPublica. In his complaint, Griffin alleges that the IRS willfully failed to establish adequate safeguards over confidential tax return information – notwithstanding repeated warnings from the Treasury Inspector General for Tax Administration and the US Government Accountability Office that the IRS’s existing systems were wholly inadequate. Griffin is seeking an order directing the IRS “to formulate, adopt, and implement a data security plan” to protect taxpayer information.

The future of Griffin’s lawsuit is uncertain. Recently, the judge in his case dismissed one of his two claims and cast doubt on the theories underpinning his remaining claim. It could be years before a final decision is entered.

Although Griffin is leading the charge, joining the fight would bolster his efforts and promote the goal of ensuring the public tax system’s integrity. A final order in Griffin’s case will be appealable to the US Court of Appeals for the Eleventh Circuit. A decision there will be binding on both the IRS and taxpayers who live in Alabama, Florida and Georgia. However, the IRS could also be bound by orders entered by other federal courts arising from lawsuits filed by taxpayers who live elsewhere. Because other courts may disagree with the Eleventh Circuit, taxpayers living in other states could file their own lawsuits against the IRS in case Griffin does not prevail.

Victims of the IRS data breach who are interested in taking legal action should act quickly. Under the Internal Revenue Code, a lawsuit must be filed within two years after the date the taxpayer discovered the data breach.

© 2024 McDermott Will & Emery
For more news on the IRS Data Breach, visit the NLR Tax section.

Good News for Offshore Wind Blows in With New Guidance From the Treasury and IRS

The Inflation Reduction Act of 2022 (IRA) includes several tax credits to encourage investment in renewable energy projects, including an Investment Tax Credit (ITC) that is worth up to 30% of the overall project cost. The developer of a renewable energy project can receive a bonus of up to 10% on top of the ITC for a qualified facility that is located or placed in service in an “energy community.” One type of area that can qualify as an energy community under the IRA — the one most relevant to offshore wind projects — is an area that has significant employment or local tax revenues from fossil fuels and a higher-than-average unemployment rate.

In order to apply the criteria to offshore wind facilities, the US Department of Treasury initially proposed that an offshore wind project would be deemed to be located or placed in service at the place closest to the point of interconnection (POI) where there is land-based equipment that conditions the energy generated by the offshore wind project for transmission, distribution, or use.

Stakeholders in the offshore wind industry believed, however, that this approach did not adequately reflect the original intent of the IRA as it neglected to take into account the long-term benefits of activity related to offshore wind projects at locations, particularly ports, that were not at the POI.

Responding to stakeholder advocacy over the past several months, on March 22, the Internal Revenue Service (IRS) released updated guidance in IRS Notice 2024-30 (the Notice). The Notice permits projects with multiple POIs to qualify for the bonus credit, so long as one of the POIs is within an energy community. Stakeholders believe that this will be key in developing the shared transmission infrastructure that will be required for effective use of offshore wind energy.

Further, the Notice permits offshore wind facilities to attribute their nameplate capacity to additional property — namely, to supervisory control and data acquisition system (SCADA) equipment owned by the owner of the offshore wind project and located in an EC Project Port (as defined in the Notice). SCADA equipment is property that is used to remotely monitor and control the operations of the offshore wind project. The SCADA system is effectively the nerve center for an offshore wind project.

An “EC Project Port” is defined in the Notice as a port that is used either full or part time to facilitate maritime operations necessary for the installation or operation and maintenance of the offshore wind project, and that has a significant long-term relationship with the project’s owner by virtue of ownership or lease arrangements. The personnel based at the port need to include staff who are employed by, or who work as independent contractors for, the project’s owner and who perform functions essential to the project’s operations. Staff based at the port will be considered to perform functions essential to the project’s operations only if they collectively perform all the following functions: management of marine operations, inventory and handling of spare parts and consumables, and berthing and dispatch of operation and maintenance vessels and associated crews and technicians.

Finally, the Notice adds two industry codes from the North American Industry Classification System (NAICS) to those that are used to determine a community meets the IRA’s required percentage of its workforce who are employed in the extraction, processing, transport, or storage of coal, oil, or natural gas. These additional NAICS codes designate oil pipeline infrastructure and natural gas distribution infrastructure. These additional codes are intended to bring the benefits of the energy community bonus credit to more communities and the IRS has amended its list of energy communities accordingly.

Advocates note that the updated guidance in the Notice represents a more holistic approach to the energy communities bonus credit that will give offshore wind project developers more flexibility in identifying ports for their investment, The increased flexibility will bring the economic benefit of the offshore wind industry to more communities, which will ultimately reduce the cost burden to ratepayers.

© 2024 Jones Walker LLP
For more news on Tax Credits for Renewable Energy, visit the NLR Tax section.

Weather & Climate Risk Management Part IV: Taxation of Weather Risk Management Products

Are there differences in the way in which weather derivatives and weather insurance are taxed?

Yes. Weather insurance products, including parametric insurance, are taxed as insurance; and derivatives are taxed in accordance with the tax rules applicable to the particular type of derivative product held by the taxpayer. A business needs to carefully consider these tax differences to determine the best product or products to meet its weather risk management needs.

How is insurance taxed to a policyholder?

When a business buys weather insurance, it pays a premium to the insurance company so that the company assumes the business risks set out in the policy. Assuring the policy is purchased to manage a business’s legitimate weather-related risk, the premium is deductible under Internal Revenue Code (Code) § 162 as an ordinary and necessary business expense.

If insurance coverage is triggered and a policyholder receives a payout under the policy, the payout is not taxable up to the policyholder’s tax basis if the payment reimburses the policyholder for property damage or loss. In other words, payments under insurance policies are not taxable up to the policyholder’s tax basis because the payments simply restore (in whole or in part) the policyholder to the financial position it was in before it incurred the loss. If the reimbursement amount under the policy exceeds the policyholder’s tax basis, the amount it receives over its tax basis is treated as taxable income.[1]

Business interruption insurance covers losses (such as lost profits and ongoing expenses) from events that close or disrupt the normal functioning of the policyholder’s business. The payout amount is often based on past business results. Business interruption insurance proceeds are likely to be taxable to the policyholder because they compensate the policyholder for lost revenue.

To ensure that a policyholder receives the most favorable tax treatment, it must carefully document its business purpose for entering into the insurance, the amount of its tax basis, and receipt of the insurance proceeds.

How are derivatives taxed?

It depends on whether the taxpayer has entered into a futures contract, forward contract, option, swap, cap, or floor. The taxpayer must then consider its status in entering into each derivative: is it acting as a hedger, dealer, trader, or investor? The taxpayer must also determine whether it has made all the required tax identifications and elections. In dealing with derivatives, the taxpayer must go through this three-step process for each product it is considering. Hedgers and dealers receive ordinary income and loss on their derivative transactions, while traders and investors receive capital gain and loss.

Why might a taxpayer want to be treated as a hedger with respect to its weather derivatives?

A taxpayer seeking to use weather derivatives to manage its weather-related business risks typically wants to be treated as a tax hedger so that the gain or loss on its derivative transactions qualify as tax hedges. This would allow the taxpayer to match its derivative gains or losses with its weather-related income or losses. Because ordinary property generates ordinary income or loss, a business hedger typically wants to receive ordinary income or loss on its weather derivatives. In other words, a hedger wants to match the tax treatment it receives on its hedges with that of the items it is hedging. Many risk management transactions with respect to weather-related risks do not meet the hedge definition (see the discussed below). For a detailed discussion of the tax hedging rules, see the forthcoming Q&A with Andie, “Business Taxation of Hedging Transactions.”

What is required for a weather derivative to be treated as a tax hedge?

To qualify as a tax hedge, the transaction must manage interest rate fluctuations, currency fluctuations, or price risk with respect to ordinary property, borrowings, or ordinary obligations.[2] In addition to meeting the definition of a tax hedge, the taxpayer must comply with the identification requirements set out at Code §§ 1221(a)(7) and 1221(b)(2) and the tax accounting requirements set out at Treas. Reg. § 1.446-4.[3]

What is the tax analysis that a taxpayer should conduct to determine if its weather derivatives qualify as tax hedges?

When entering into a weather derivative, a taxpayer should conduct the following tax analysis: (1) is the transaction entered into in the ordinary course of its trade or business (2) primarily (3) to manage price risk (4) on ordinary property or obligations (5) held or to be held by the taxpayer. If the answer to all of these questions is “yes,” then the taxpayer has a qualified tax hedge if—but only if—it complies with all of the required identification rules set out in Code §§ 1221(a)(7) and 1221(b)(2) and as explained in Treasury Regulation § 1.1221-2. If the taxpayer cannot answer all of these questions with a “yes,” then the weather derivative transaction is not a tax hedge, and it is subject to the tax rules that apply to capital assets.[4] The requirement that a taxpayer must be hedging ordinary property, borrowings, or obligations means that favorable tax hedging treatment is not available for many legitimate weather risk management activities.

What types of assets, obligations, and borrowings qualify as ordinary property and ordinary obligations for purposes of the tax hedging rules?

Weather derivatives qualify as tax hedges if they can be tied to price risk with respect to ordinary assets or ordinary obligations. In many situations, however, weather derivatives are entered into to manage a taxpayer’s anticipated profitability, sales volume, plant capacity, or similar issues. These risks are not the transactions that receive tax hedge treatment.

Ordinary property includes property that if sold or exchanged by the taxpayer would not produce capital gain or loss without regard to the taxpayer’s holding period. Items included in a taxpayer’s inventory—such as natural gas or heating oil held by a dealer in those products—are treated as ordinary property that can be hedged. Qualifying hedges can also include hedges of purchases and sales of commodities for which the taxpayer is a dealer, such as electricity, natural gas, or heating oil. If a utility agrees to purchase electricity at a fixed price in the future, for example, the utility is exposed to price risk if it cannot resell the fixed-price electricity for at least the amount it paid to purchase that electricity. Accordingly, the utility could agree to sell electricity under a futures contract (short position) that would qualify as a tax hedge.

On the liability side of a business, the hedge could relate to a taxpayer’s price risk with respect to an ordinary obligation. An ordinary obligation is an obligation the performance of which (or its termination) would not produce a capital gain or loss. For example, a forward contract to sell electricity or natural gas at a fixed price entered into by a dealer is treated as an ordinary obligation. In addition, a utility that enters into a fixed price forward sales contract agreeing to sell electricity at a fixed price has an ordinary obligation to deliver electricity at that fixed price.

What sorts of weather derivative transactions are not tax hedges?

Many legitimate risk management activities do not qualify as tax hedges. Weather derivative transactions that protect overall business profitability (such as volume or revenue risk) are not directly related to ordinary property or ordinary obligations. As a result, weather derivatives entered into to protect a business’s revenue stream or its net income against volume or revenue risk are not tax hedges.

Many taxpayers in the normal course of their businesses enter into weather derivatives to manage volume or revenue risks of reduced demand for their products or services. These transactions are not tax hedges. The taxpayer is not managing a price risk (either current or anticipated) attributable to ordinary assets, borrowings, or ordinary obligations.

Take, for example, a ski resort or amusement park operator that enters into a weather derivative to protect itself against adverse weather conditions that are likely to result in a reduction in the number of skiers or amusement park visitors. The taxpayer’s risk management efforts in these cases either relate to its investment in its facility (which for the most part consists of real estate and business assets that are not taxed as ordinary assets) or to its expected revenue. Similarly, a power generator that hedges its plant capacity or its revenue stream with a weather derivative tied to the number of Cooling Degree Days would not meet the definition of a tax hedge.

Why don’t more weather derivatives qualify as tax hedges?

As part of Congress’ efforts to modernize the tax rules with respect to hedging, it specifically authorized the Treasury to issue regulations to extend the hedging definition to include other risks that the Treasury sets out in regulations.[5] The Treasury, unfortunately, has not proposed or issued any regulations extending the benefits of tax hedging. This means that weather derivative transactions entered into to manage weather-related volume or revenue risks do not qualify as tax hedges. In this situation, the taxpayer receives capital gain or loss on the derivative product.

What are some examples of weather derivatives that can qualify as tax hedges?

A weather derivative qualifies as a tax hedge if it manages the taxpayer’s price risks with respect to ordinary assets or obligations. Thus, a taxpayer entering into weather derivatives primarily to manage its price risk with respect to increased supply costs will meet the definition of a hedging transaction. Such a transaction manages the taxpayer’s price risks with respect to ordinary property.

If, for example, a commodity dealer buys a put option (or sells a call option) on a designated weather event to protect it against price risks with respect to its existing inventories or future fixed-price commitments, the dealer has entered into a qualified tax hedge, provided it meets the identification requirements.

A heating oil distributor with heating oil inventory (or forward contracts to purchase heating oil at a fixed price) might enter into a weather swap to protect itself from the risk of an unseasonably warm heating season. This swap should qualify as a tax hedge because the swap manages the distributor’s risk of a decline in the market price for its heating oil inventories (or a decline in its fixed-price forward contract purchase commitments) due to unseasonably warm weather.

If an electric utility enters into forward commitments to sell electricity at fixed prices for delivery in the summer cooling months, it may buy a call option on a designated weather event that would qualify as a tax hedge to the extent the option protects the utility against the risk of being unable to acquire or generate the electricity at a low enough price if the demand for electricity in the cooling season is higher than expected because of unseasonably warm weather resulting in higher electricity prices.

Conclusion

All organizations face weather and climate risks. As part of their enterprise-wide risk management, they have available to them a number of weather risk transfer tools. This series on weather and climate risk provides a detailed review of weather risk management. Organizations can look to standardized futures and option contracts traded on regulated commodity exchanges; they can enter into customized OTC weather derivatives designed with their specific weather risks in mind; they can put in place indemnity insurance; they can purchase parametric insurance; or they can mix and match multiple derivative products and insurance coverages to meet their specific organization’s needs. In Part I of this Q&A series on Weather & Climate Risk Management, we considered the landscape and context within which weather and climate decision making takes place, along with the overarching risk management approaches and principles that apply. In Part II, we looked at the details on the various weather risk management products. In Part III, we addressed the regulation of these products; and in Part IV, we reviewed the taxation of these various classes of products.

[1] Taxability is subject to a nonrecognition provision at Code § 1033(a) if the taxpayer complies with the requirements to purchase “qualified replacement property.” https://irc.bloombergtax.com/public/uscode/doc/irc/section_1033

[2] Treas. Reg. § 1221-2 and Code §§ 1221(a)(7) and 1221(b)(2).

[3] For a detailed discussion of the tax hedging rules see my forthcoming Q&A with Andie, “Business Taxation of Hedging Transactions” due out in Spring 2024.

[4] If the taxpayer is a dealer or a commodity derivatives dealer, the weather derivative would be an ordinary asset in the taxpayer’s hands.

[5] Code § 1221(b)(2)(A)(iii).

© 2024 ASKramer Law
For more news on the Taxation of Weather Risk Management Products, visit the NLR Environmental, Energy & Resources and Tax sections.

How Big is the Permanent Tax Benefit in the Pending Tax Bill for Research Credit?

Congress perhaps made an unintended drafting error in the Tax Cuts and Jobs Act [1] (TCJA) when it required a taxpayer to decrease its deduction for research and experimental expenditures. The apparent drafting error is in IRC §280C(c)(1), which provides that if a taxpayer’s research credit for a taxable year exceeds the amount allowable as a deduction for research expenditures for the taxable year, the amount of research expenses chargeable to capital account must be reduced by the excess and not by the full amount of the credit.

H.B. 7024 (1-17-24) [2] proposes to correct the drafting error for tax year 2023 and expressly states that the amendment made for taxable year 2023 should not be construed to create an inference with respect to the proper application of the drafting error for taxable year 2022. [3] The “no inference” congressional language could be interpreted as inviting the IRS to attempt an administrative fix of the drafting error.

Background of Research Expenditure Deduction and Credit for Increasing Research Activities: Beginning with the Internal Revenue Code of 1954, a taxpayer engaging in research activities in the experimental or laboratory sense in connection with its trade or business could elect to deduct the cost of its research currently rather than capitalizing the cost to the project for which the research was conducted. The Economic Recovery Tax Act of 1981 added a credit for the cost of research incurred in carrying on a trade or business. The manner in which the deduction and credit operated permitted a taxpayer both to deduct and credit the same research dollar.

Pre-TCJA (2017) law: The Omnibus Budget Reconciliation Act of 1989 ended the possibility deducting and crediting the same research dollar. If a taxpayer currently deducted its research expenditures, the taxpayer had to decrease its deduction by the amount of the research credit that it claimed for the taxable year.[4] The policy reason for the decrease was that a taxpayer should not be entitled to a deduction and a credit for the same dollar expended for research. Put another way, if the government “pays” for research by allowing a credit, the taxpayer did not really pay for the research and should not be entitled to deduct the amount for which the government paid.

TCJA Amendment: The TCJA now requires a taxpayer to capitalize research expenditures paid or incurred in the taxable year and claim an amortization deduction for the expenditures ratably over a five-year period.[5] The TCJA also amended IRC §280C(c)(1), the provision that prevents a taxpayer from receiving a credit and a deduction for the same dollar of research expenditure. The amendment provides that if the research credit amount for the taxable year exceeds the amount allowable as a deduction for the taxable year for qualified research expenses, the research expenses chargeable to capital account for the taxable year must be reduced by the excess.[6] This might have been a drafting error. The research credit for the taxable year might not exceed an amortization deduction for the year.[7] If for a taxable year the credit does not exceed the amortization deduction, a taxpayer could reasonably conclude that no reduction in the amount of capitalized research expenditures is required. The taxpayer would be interpreting the deduction for qualified research expenses as meaning the amount of the amortization of the capitalized expenses.

The IRS might have an opposing interpretation. The phrase, “the amount allowable as a deduction for such taxable year for qualified research expenses” in IRC §280C(c)(1) could be interpreted as always equaling zero because the TCJA amendment requiring amortization of research expenditures for the taxable year nullifies the “deduction … for qualified research expenses.” In other words, there were no “deductible” qualified research expenses for the year after enactment of the TCJA for purposes of IRC §280C(c)(1). [8] The result would be that the capitalized research expenses are decreased by the amount of the credit.

H.B. 7024: On January 31, 2024, the House passed 353 to 70 H.B. 7024, “Tax Relief for American Families and Workers Act of 2024.” Action on the bill is pending in the Senate. The bill restores the current deduction for research expenditures (but only for research performed in the United States), beginning with taxable year 2022,[9] and defers the requirement to amortize research expenditures until taxable year 2026. For taxable years beginning in 2023, the bill requires a taxpayer to decrease the research expenditure deduction for domestic research by the amount of the research credit for the year, thus reinstating, for domestic research, IRC §280C(c)(1) as it had read prior to its amendment by the TCJA. [10]

But for taxable year 2022, the bill does not expressly require a taxpayer to reduce its deduction for research expenditures by the amount of the research credit even though the bill permits the taxpayer to deduct it research expenditures currently for taxable year 2022. Thus, for taxable year 2022, a taxpayer may deduct its research expenditures but must decrease the deduction only by the amount, if any, that its 2022 research credit exceeds its 2022 deduction for qualified research expenditures, which amount may be zero. Moreover, the bill provides that the amendment requiring a decreased deduction for research expenditures for taxable years beginning in 2023 should not be construed to create “any inference” with respect to the proper application of IRC §280C(c) to taxable year 2022.

IRS Notice: In Notice 2023-63 – obviously published before H.R. 7024 – the IRS asks for comments about to interpret the current version of IRC §280C(c)(1). If H.R. 7024 is enacted, the IRS request for comments would appear irrelevant.

Taxpayer Actions: If H.R. 7024 is enacted, taxpayers must consider whether to change their accounting method for research expenditures from amortizing them to currently deducting them. A change would affect many tax calculations, and obviously the only means by which to be certain of the effect is to run the change using various scenarios through the taxpayer’s tax software.

One of the effects to consider if the bill passes is the item discussed in the alert in which the taxpayer reads IRC §280C(c)(1) advantageously for taxable year 2022 and reduces its research expenditure deduction by the amount that the research credit exceeds the deduction for research expenditures for the year, which reduction amount may well be zero. The taxpayer would have a substantial permanent tax benefit by not decreasing its credit and not decreasing it deduction.

If H.B. 7024 is not enacted, a taxpayer might moderate the risk that the IRS will prevail on the interpretation of IRC §280C(c)(1) by electing to decease its credit under IRC §280C(c)(2).[11] But the taxpayer could be more aggressive by taking the position that it is applying IRC §280C(c)(1) and rarely, if ever, does it have to reduce its deduction for research expenditures. That means that the taxpayer that had historically decreased its credit in order to take the full deduction might not have to do so. That might be a very substantial permanent tax benefit.

[1] P.L. 115-97 115th Cong. 1st Sess. (12-22-17).

[2] 118th Cong., 2d Sess.

[3] H.B. 7024, Sec. 201(e)(4).

[4] Instead of decreasing the deduction, the taxpayer could elect to decrease its research credit by multiplying the credit amount by the corporate tax rate. IRC §280C(c)(2). Regardless of whether the taxpayer reduced its deduction or its credit, the federal income tax cost was the same. Many taxpayers elect to reduce the credit so that the full amount of the deduction flows into taxable income of states that conform state taxable income to federal taxable income.

[5] IRC §174(a)(2)(B). The deduction is spread over six taxable years because the taxpayer may deduct for the first amortization year only half of a full year’s amortization. If the research is performed outside the United States, the amortization period is fifteen years.

[6] IRC §280C(c)(1).

[7] For example, assume qualified research expenses for the taxable year 2022 of $1,000 and minimum base amount of $500. The research credit is $100 (20% times $500). The credit does not exceed the amortized deduction – $100 for the first taxable year.

[8] Of course, there were qualified research expenses identified for the research credit.

[9] Proposed IRC §174A(a). A taxpayer that had capitalized and amortized its research expenditures as required by the TCJA may file an amended return for tax year 2022 and deduct research expenditures paid or incurred for that year. Alternatively, the taxpayer may elect to adjust its taxable income under IRC § 481 by taking a favorable adjustment into account in taxable year 2023. Alternatively, it may elect to make the adjustment over taxable years 2023 and 2024. H.B. 7024, sec. 201(f)(2).

[10] The taxpayer could still elect to decrease its credit in lieu of reducing its deduction.

[11] See supra note 4.

© 2024 Miller, Canfield, Paddock and Stone PLC
For more on the Research Credit Tax Bill, visit the NLR Tax section.