On March 21, 2023, the IRS and the U.S. Treasury Department (Treasury) issued proposed regulations providing guidance to taxpayers on the Advanced Manufacturing Investment Credit (the CHIPS Act tax credit) under the Creating Helpful Incentives to Produce Semiconductors Act of 2022 (CHIPS Act).
Here are some common questions you may be asking about this tax credit that the proposed regulations provide insight on:
Who Can Claim This Credit?
Any taxpayer is eligible to claim this credit if they are not a “foreign entity of concern” and have not made an “applicable transaction” during the taxable year. For purposes of the CHIPS Act tax credit, the U.S. Department of Commerce issued guidance on March 21, 2023 defining “foreign entity of concern” to include, but not limited to, foreign entities designated as a foreign terrorist organization by the Secretary of State, and other federal legislation and Treasury lists. Applicable transactions are defined in Section 50(a)(6) as material expansions of semiconductor manufacturing capacity in China or a foreign country of concern. Note that if a taxpayer claims this credit but then engages in an applicable transaction within 10 years of placing the credit-eligible property in service, the taxpayer will be required to recapture all the CHIPS Act tax credits claimed. The recapture amount is computed by determining the tax amount if the credits in prior years for the manufacturing incentive had been reduced to zero.
How Is the Credit Calculated?
The CHIPS Act tax credit is equal to 25% of any qualified investment, e.g., the basis of any qualified property, that is part of an advanced manufacturing facility and placed in service by the taxpayer after December 31, 2022. If construction began prior to January 1, 2023, the CHIPS Act tax credit is only available to the extent of the basis of qualified property attributable to the construction, reconstruction, or erection after the CHIPS Act was enacted on August 9, 2022.
The requirements to be treated as qualified property include:
- Tangible property with respect to which depreciation or amortization is allowable
- Constructed, reconstructed, or erected by the taxpayer or acquired by the taxpayer (if the original use of the property commences by the taxpayer)
- Integral to the operation of an advanced manufacturing facility whose primary purpose is manufacturing semiconductors or semiconductor manufacturing equipment. Property is integral to the manufacturing process if it is used directly in the manufacturing operation and is essential to the completeness of the manufacturing operation. A research or storage facility may be considered qualified property if it is used in connection with the manufacturing of semiconductors or semiconductor manufacturing equipment
For pass-through entities, the proposed regulations clarify that a partner or shareholder is treated as the taxpayer with respect to the partner’s or shareholder’s share of basis in the partnership’s qualified property for purposes of calculating the qualified investment. A partner’s share of the partnership’s basis should be determined in accordance with the ratio in which the partners divide the partnership’s general profits or otherwise determined under Regulation §1.46-3(f). For S corporations, the basis of qualified property must be apportioned pro rata among the shareholders. Similar rules apply to estates and trusts. This means that partnerships and S corps with qualifying property may pass through a portion of the qualified basis to the ultimate taxpayers who may claim a credit, subject to any limits at the partner or shareholder level.
Which Facilities Are Eligible for the CHIPS Act Tax Credit?
The facility’s primary purpose must be to manufacture finished semiconductors or semiconductor manufacturing equipment. This is a facts and circumstances test; however, the proposed regulations do clarify that a facility that manufactures, produces, grows, or extracts materials or chemicals that are supplied to an advanced manufacturing facility that manufactures semiconductors, or semiconductor manufacturing equipment, does not meet the primary purpose requirement. Facts that may indicate a facility has a primary purpose of manufacturing finished semiconductors or manufacturing finished semiconductor manufacturing equipment include:
- Designs or other documents that demonstrate that the facility is designed to make finished semiconductors or finished products consisting of specialized equipment that can only be used for semiconductor manufacturing
- Possession of permits or licenses needed to manufacture finished semiconductors or finished semiconductor manufacturing equipment; and
- Executed contracts to supply finished semiconductor manufacturing equipment to a finished semiconductor manufacturer in place either before or within six months after the facility is placed in service
Treasury is asking for comments on whether for purposes of the CHIPS Act tax credit, the definition of “semiconductor” should include semiconductive substances on which an electronic device or system is manufactured, e.g., polysilicon and compound semiconductor wafers.
When Does Construction Have to Begin for the Facility to Be Eligible for the CHIPS Act Tax Credit?
Construction of the property must begin before January 1, 2027. To help establish that construction has begun, the proposed regulations provide the Physical Work Test or the Five Percent Safe Harbor:
- Physical Work Test: Construction begins when physical work of a significant nature begins (on site or off site, performed by the taxpayer or by a third party under a binding contract). This test is based on the nature of work performed, not the amount of costs. Note that physical work of significant nature does not include preliminary activities, including but not limited to planning or designing, securing financing, exploring, researching, obtaining permits, licensing, conducting surveys, environmental and engineering studies, or clearing a site, even if the cost of those preliminary activities is properly included in the depreciable basis of the property.
- Five Percent Safe Harbor: Construction is considered to have begun if the taxpayer pays or incurs 5% or more of the total cost of the property, e.g., all costs included in the basis of the property.
Under either the Physical Work Test or the Five Percent Safe Harbor, the taxpayer also must prove that there was either continuous construction, e.g., continuing physical work of a significant nature, or continuous efforts to advance toward completing the property, like entering into binding contracts, obtaining permits, and paying bills that go toward the costs of the property.
What Is the Direct Pay Option?
Eligible taxpayers may elect to treat the CHIPS Act tax credit as a payment against their federal income tax equal to the credit amount, even if the taxpayer has zero tax liability, effectively resulting in a refundable credit. If the taxpayer has zero tax liability, this effectively converts the credit into cash. This election must be made no later than the due date (including extensions) of the tax return for the taxable year in which the election is made, but in no event earlier than May 8, 2023. This election is irrevocable. For pass-through entities, the direct pay election must be made by the partnership or S corp that directly holds the property for which the CHIPS Act tax credit is claimed; the election is not available to the partner or shareholder.
If your company is interested in taking advantage of the CHIPS Act tax credit for semiconductor manufacturers, reach out to a professional at FORVIS or use the Contact Us form below.
If you’re interested in also learning about the other CHIPS Act funding available for semiconductor manufacturers under the CHIPS for America Fund, see FORsights™ article, “Guidance Released on How to Apply for CHIPS Act Funding.”