The Inflation Reduction Act, signed into law on Aug. 16, 2022, allows for the purchase and sale of certain energy related federal tax credits, like many states already allow.
On June 14, 2023, the IRS and the Treasury Department released proposed rules RIN-1545-BQ64 that provide a measure of clarity around several procedural and substantive aspects of transferring federal tax credits under the Inflation Reduction Act.
The clarity should further accelerate the rapidly expanding transferable credit market, which is already bringing together developers, asset owners and a diverse group of taxable buyers seeking to purchase credits at a discount to satisfy their tax liability while earning an attractive return on investment.
Tax credit transfers
Internal Revenue Code (IRC) Section 6418, established under the Inflation Reduction Act, allows eligible taxpayers to elect to transfer certain energy related federal tax credits in whole or in part to an unrelated third party. The third party must pay cash, rather than providing a note or other property in exchange.
Credit transfers related to progress expenditures aren’t allowed and will require the project to be in service for the credit transfer. Additionally, credits passed through to a lessee through an election under Code of Federal Regulation Section 1.48-4 are not transferable.
Purchased tax credits may only be transferred once and have a three-year carryback and 22-year carryforward.
An election to transfer a credit earned by a flow-through entity, including S corporations (S corp), is made at the entity level. Nothing in the regulations prevents a tax equity partnership or other tax-equity vehicle from selling some or all the credits it’s allocated. However, bonus credits cannot be separately transferred.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
The basis of the property related to the credit is subject to a 50% reduction of the amount of the credit under IRC Section 50(c).
Timing considerations
The buyer may first utilize a credit in the taxable year a project is placed in service based on the seller’s tax year. For example, if a seller has a calendar tax year and a buyer has a March 31, 2023 fiscal year-end (FYE), and the seller places in service a project on Feb. 1, 2023, the buyer can’t use the credits until their 2023 tax year, FYE March 31, 2024.
Additionally, buyers may consider a credit that has been purchased, or will be purchased, when calculating estimated tax payments however, the buyer remains liable for any additional tax to the extent the buyer has an underpayment of estimated tax.
Federal tax impact of credit transfers
The cash payment to the transferor isn’t taxable income, and the payment by the transferee isn’t deductible as a tax payment or other business deduction. Any gain that would be otherwise recognized by the buyer because of purchasing a credit at a discount is also not taxable income.
Pass-through entities are eligible purchasers of federal transferable credits. However, the regulations take the position that passive activity rules apply at the partner level. This generally means individuals and closely held corporations will be restricted in their ability to use credits to shelter non-passive activity income, such as business income received in a limited partner or other passive capacity.
State tax impact of credit transfers
It remains to be seen how states will treat the proceeds from federal tax credit transfers and corresponding payments, as not all states conform to the IRC.
This lack of conformity could result in disparate treatment of the gain on the sale and purchase discount among the states.
Transfer processes
Learn when to transfer credits and the related registration requirements.
When to transfer
Elections to transfer these certain credits may be made no later than the extended due date of a transferor’s tax return. Once made, such an election is irrevocable.
Registration and transfer processes
To transfer an eligible credit, you’ll first need to complete the electronic pre-filing registration with the IRS to receive a registration number for each eligible project.
Information required for registration includes identifying specific taxpayer data and project qualification information.
Pre-filing registration requirements
Information required for registration includes:
Name, address, federal employer identification number, tax year, type of entity, and annual form — if applicable — filed with the IRS
Type of eligible credits and amount the transferor intends to transfer
Date construction commenced and when the eligible facility was placed into service
Any other information the IRS portal requires, such as type of eligible property, physical address or location, and any documentation relating to construction or acquisition of the eligible property for which a tax credit is being calculated
Name of a contact person for the eligible taxpayer that has the legal authority to bind the taxpayer or a representative with a signed Form 2848
Upon submission of the pre-registration, the person submitting the application must sign under penalties of perjury that all the information is accurate to the best of their knowledge and the application is complete.
This step should be taken with sufficient time to receive a valid registration number by the time of filing of the tax return, including extensions. The registration platform is expected to become available later in 2023.
In addition to a registration number, both parties must complete a transfer election statement that will be attached to the tax return along with Form 3800 for General Business Credits.
Transfer registration statement requirements
The proposed rules outlined the required elements of a valid transfer election statement. They include the following:
Name, address, and taxpayer federal employer identification number for both the transferor and transferee
Description of the type, year, and amount of the eligible tax credit transferred and the timing and amount of cash paid for the eligible tax credit transferred
A statement that the parties aren’t related to one another and that they’ll comply with the IRC Section 6418 regulations including those related to recapture notifications
The registration number related to the eligible credit property
A statement that all the minimum documentation requirements of the proposed regulation have been provided by the transferor to the transferee
A purchase and sale agreement may be used as a transfer election statement if it meets the criteria for the statement. Other information may include other documentation to validate the existence of the eligible credit property, any bonus credits amounts, and the evidence of credit qualification.
Initial transactions include a form populated transfer election statement as an exhibit to the purchase and sale agreement, which will ultimately be attached to the transferor and transferee tax returns.
buyer and seller considerations
Credit buyers are considered the liable party for any recaptured credits that are transferred. The transferor is required to notify the transferee if a recapture event occurs.
Because of this, buyers and sellers may consider an indemnification clause and insurance against credit risks.
Additionally, a buyer will want to confirm the seller is eligible to transfer the credit. For example, a lessee of credit eligible property that’s passed through a credit by the lessor or owner isn’t eligible to transfer the credit, as they’re not the owner of the credit eligible property.
Tax credit transfer agreement considerations
Tax credit buyers should work with their tax and legal advisors when drafting tax credit transfer purchase and sale agreements to determine appropriate protections and indemnification clauses.
Buyers may also ask for an independent CPA project cost audit of the tax credit eligible basis and a valuation of the tax credit eligible project, as well as an audit or other analysis of compliance with prevailing wage and apprenticeship requirements.
Consideration will also need to be given to post-construction risks such as recapture and ongoing prevailing wage and apprenticeship compliance, as well as credit support, such as parent guarantees or tax insurance.
Insurance against credit risks
Purchasers of credits may consider purchasing insurance or require the seller to insure the credit against certain risks. Tax credit insurance has a long history, though its current use typically applies to tax equity transactions for many credit programs.
The four most common risks in tax equity transactions are:
Structure
Qualification
Valuation
Recapture
The year of the credit could also be a risk if an IRS audit deemed the facility wasn’t placed into service during the year the credit was transferred and applied. With some of the initial IRC Section 6418 transactions, the insurance policies address the above risks.
Potential limitations for applicable corporations
The act imposes a new 15% corporate alternative minimum tax (CAMT) on certain applicable corporations to the extent their tentative minimum exceeds the regular U.S. federal income tax liability plus liability for the base erosion and anti-abuse tax (BEAT).
An applicable corporation's tentative minimum tax is a 15% minimum tax on its annual adjusted financial statement income (AFSI) to the extent it exceeds the CAMT foreign tax credit for the tax year.
If a corporation is subject to the CAMT, the corporate tax may be reduced by tax credits under the Inflation Reduction Act provisions. The total credit is limited if 75% of the taxpayer's net income tax exceeds $25,000 — with no limit against the first $25,000.
Transferable tax credit market variables
With the issuance of this guidance, the market for federal transferable tax credits is beginning to quickly take shape.
Discounts for buyers range from 5% to 15% or more depending on a variety of factors, such as:
Size of credit
Strength of indemnity or guarantor
Timing of transfer and payment
Quality of energy offtake agreements
Existence of tax credit insurance
Timing of final rules and guidance issued by the IRS
