Cost Segregation Can Enhance the New Semiconductor Manufacturing Credit

The U.S. semiconductor industry received a large boost recently with passage of the CHIPS Act, signed into law on August 9, 2022. Aimed at spurring domestic semiconductor research and production, the bill contains a number of incentives, including the new advanced manufacturing tax credit (AMTC) under Section 48D of the Internal Revenue Code.

The AMTC provides an income tax credit of 25% for qualified investments in advanced manufacturing facilities placed in service after December 31, 2022. The new law also allows for a direct pay option, which essentially makes the credit refundable.

Consider assessing the credit in conjunction with a cost segregation study, which is designed to identify all eligible assets and costs. This planning strategy may provide your organization with enhanced benefits in the form of both accelerated depreciation and the new AMTC.

Review these key terms and concepts to get started.

What investments qualify for the AMTC?

A qualified investment means the basis of qualified property placed in service by an eligible taxpayer which is part of an advanced manufacturing facility.

Qualified property generally means tangible property integral to the operation of an advanced manufacturing facility that is (i) constructed, reconstructed, or erected by the taxpayer, or (ii) acquired by the taxpayer if the original use of such property commences with the taxpayer.

Qualified property includes buildings and their structural components that meet the requirements above. However, portions of a building used for offices, administrative services, or other functions unrelated to manufacturing do not qualify for the credit.

Under this broad definition, a multitude of assets can qualify for the AMTC, including new equipment purchased for semiconductor manufacturing as well as the construction, expansion, or renovation of the facilities in which the manufacturing activities occur.

What is a qualified facility?

An advanced manufacturing facility is a facility the primary purpose of which is the manufacturing of semiconductors or semiconductor manufacturing equipment.

In other words, the credit applies not only if your organization is engaged directly in semiconductor fabrication, but also if you manufacture equipment for such fabrication. This may provide opportunities for manufacturers across a wide spectrum, including downstream suppliers whose products are built primarily for integration into larger pieces of semiconductor equipment.

What is an eligible taxpayer?

An eligible taxpayer is one that is not a foreign entity of concern (as defined in Section 9901(6) of the National Defense Authorization Act for Fiscal Year 2021) and has not engaged in an applicable transaction during the taxable year. An applicable transaction means one involving the material expansion of semiconductor manufacturing capacity in the People's Republic of China or a foreign country of concern.

How is the AMTC claimed?

The AMTC can be claimed directly against federal income tax if your organization has sufficient tax liability to absorb it. However, Section 48D also offers an elective direct payment option. In this case, you would be treated as having made a payment against your federal income tax equal to the amount of the credit. The election, which is irrevocable, thus acts as an estimated tax payment that can result in a cash refund of the credit.

In the case of partnerships and S corporations, the election must be made at the entity level, and the credit will be paid directly to such entity. The payment will then be treated as tax exempt income that is passed through to the partners or S corporation shareholders.

The direct payment election must be made no later than the due date (including extensions) of the entity’s income tax return for the year for which the election is made. However, in no event can the election be made earlier than 270 days after the date of enactment of Section 48D (August 9, 2022). The IRS must still set forth specifics in connection with the manner of the election.

How long is the AMTC available?

The AMTC applies to qualified property placed in service after December 31, 2022, the construction of which begins prior to January 1, 2027. For construction beginning prior to January 1, 2023, the credit is available only to the extent of the basis attributable to the construction, reconstruction, or erection incurred after August 9, 2022. Thus, it will be important to identify the date construction begins when claiming the AMTC — and such a determination may not be straightforward. Consider the type and extent of the work performed to establish when construction commences for this purpose.

How does the AMTC affect basis?

When the AMTC is claimed, you must reduce the basis of the qualified property by the amount of the credit — the basis reduction applies whether the credit is used against tax or received as a direct payment.

How does recapture apply to the AMTC?

If you dispose of qualified property within one full year after it is placed in service, 100% of the AMTC must be recaptured. The recapture percentage is reduced by 20% for each subsequent year beginning in year two. Also, 100% of the credit must be recaptured when the taxpayer engages in an applicable transaction (as described above) within 10 years of the property being placed in service.

Why should a cost segregation study be performed?

Cost segregation is a tax planning strategy whereby buildings are broken down into their constituent parts to identify items of real and personal property eligible for accelerated depreciation lives (typically 5, 7, or 15 years). In many instances, the assets may also be eligible for bonus depreciation, which is currently 100% through the end of 2022 — thereafter, the bonus percentage phases down 20% each year.

Manufacturing facilities tend to generate substantial benefits through a cost segregation study, in large part due to the opportunity to segregate mechanical, electrical, and piping assets that are dedicated to operating manufacturing equipment. This requires a detailed engineering analysis of each asset and its function on a standalone basis and as part of an integrated system.

Since Section 48D applies to buildings and their structural components, a cost segregation study should be part of your AMTC strategy. Even with the required basis reduction under Section 48D, cost segregation can generate valuable accelerated depreciation while also identifying qualified property for the AMTC. Additionally, a cost segregation study can help in determining when construction commenced for purposes of determining AMTC eligibility.

How we can help

CLA’s cost segregation and tax credit professionals help clients capture tax incentives associated with their fixed asset investments. Our team includes engineers that have a deep knowledge of manufacturing facilities and the various equipment and systems that power them. Contact us to learn how your organization can take advantage of this tax planning opportunity.