As part of the Inflation Reduction Act (“IRA”) passed in August of 2022, $391 billion of governmental funding was allocated to energy and climate initiatives. The ability to transfer (i.e. sell) clean energy credits was part of the new legislation and covered under IRC Section 6418. The intent of IRC Section 6418, was to increase participation in clean energy initiatives by allowing taxpayers to sell credits without engaging in complicated tax structures. The much-anticipated Internal Revenue Service (“IRS”) regulations were released this month and provide additional guidance to a growing subsidy market for clean energy. The proposed regulations detail an intensive documentation process and limits the ability to utilize purchased credits to a narrow field.
IRC Section 6418 also provides for a one-time transfer of designated clean energy credits to an unrelated party for cash. Such a transfer does not create gross income for the taxpayer selling the credit or a deduction for the taxpayer purchasing the credit.
What credits are available to be transferred?
- IRC Section 30C alternative fuel vehicle refueling property credit
- IRC Section 48 ITC and investment tax credit (ITC) (new IRC Section 48E)
- IRC Section 45 production tax credit (PTC)
- IRC Section 45U zero-emission nuclear power production credit
- IRC Section 45X advanced manufacturing production credit
- IRC Section 45Z clean fuel production credit
- IRC Section 48C qualifying advanced energy project credit
- IRC Section 45Q carbon capture use and sequestration (CCUS) credit
- IRC Section 45V clean hydrogen production credit
- The technology-neutral PTC (new IRC Section 45Y)
Two commonly utilized credits, Section 30D clean vehicle credit and Section 45W clean commercial vehicle credits are not deemed transferable credits.
Who can make a transfer election?
An eligible taxpayer who can make a transfer is anyone other than one who can make a direct-pay election. Generally, entities that can make a direct-pay election include tax-exempt organizations, State or political subdivisions, local governments, Indian tribal governments, Alaska Native Corporations, the Tennessee Valley Authority, rural electric co-ops, U.S. territories, or an agency or instrumentality of a state, local, tribal, or territorial government.
In the case of a partnership or S corporation that holds eligible credit property directly, partners and shareholders are not allowed to transfer the credits. Instead, the partnership or S corporation must elect to transfer the credit.
Once an election is made to transfer a credit, it is irrevocable. In addition, only one transfer per credit is allowed. For example, a taxpayer that purchases a credit cannot subsequently sell the same credit.
Is a taxpayer allowed to transfer only a portion of their credits?
An eligible taxpayer can transfer any portion of an eligible credit on its original tax return. However, the regulations define a specified credit portion to mean a proportionate share of the entire eligible credit determined. Many of the clean energy credits start with a base credit and can then be significantly increased provided the prevailing wage and apprenticeship requirements, domestic, or location requirements are met. Buyers of credits sometimes only desire to purchase the base credit, as the certification and documentation of the additional requirements come with additional risk. The regulations clearly state that the division And sale of only a portion of the credit, for example just the base credit, is not allowed.
A taxpayer transferring their credits can make multiple transfer elections to multiple taxpayers provided that the total amount transferred does not exceed the total amount of the eligible credit.
How do the regulations define the term “paid in cash”?
“Paid in cash” means a payment in United States dollars that is made by cash, check, cashier’s check, money order, wire transfer, automated clearing house (ACH) transfer, or other bank transfer of immediately available funds. In addition, the amount paid must be made during a designated time period, starting with the first day of the taxable year in which the transferor determines the credit and ending on the due date for completing a transfer election statement (generally, the extended due date of the original tax return).
No transfer election is allowed if the transferor receives any consideration other than cash in connection with the credit transferred.
Can taxpayers use a dealer to assist in selling the credits?
The IRC and regulations clearly state that credits can only be transferred once. Therefore, a taxpayer must ensure that if a broker is utilized, it is not deemed as owning any of the specified credit. Instead, a broker should merely assist in matching the taxpayer with desired buyers (transferees).
Are there limitations on the amount of credit that can be transferred from a partnership or S corporation?
The amount of the credit that can be transferred by the S corporation or partnership is determined after applying the section 49 at-risk rules at the partner or shareholder level at the close of the taxable year. Therefore, if the credit base of the investment credit property is limited to a partner or shareholder by section 49, then the amount of the eligible credit determined by the transferor partnership or transferor S corporation is also limited. Section 49 generally requires the credit base of applicable property to be reduced by the amount of nonqualifed nonrecourse financing as of the close of the taxable year in which the property is placed in service. If there is a Section 49 limitation and the amount of qualified recourse debt increases in a later year, suspended credits can be released. However, if the amount of qualified recourse debt decreases later on, then there is a recapture of previously allowed credits.
What is the tax treatment of a partnership or S corporation that sells credits (i.e. transferor)?
A partnership or S corporation does not recognize income on the sale of its credits. The amount of cash received as consideration for the transferred credit is treated as tax-exempt income by the partnership or S Corporation transferring the credit. The tax-exempt income is categorized as investment activity income to the transferor.
Transferor partnerships received a welcome benefit under the proposed regulations regarding partial credit transfers. Included in the proposed regulations is the ability for partnerships that sell only a portion of their credits to specially allocate the tax-exempt income to certain partners and the remaining credit to other partners. This special rule allows partnerships to allocate the credit to partners who wish to utilize the credit and allocate tax-exempt income to members who most likely could not utilize the credit directly.
What is the tax treatment of a partnership or S corporation that purchases a credit (i.e. transferee)?
A partnership or S corporation does not recognize a deduction on the purchase of the credits. A transferee would consider the purchased credit as earned in connection with the conduct of a trade or business, and therefore the passive activity limitation rules of Section 469 apply. The credits cannot offset wages, active business income, or investment income. The requirement that the transferee only utilize the credit against the tax imposed on passive income was an unexpected item in the proposed regulations. Such a limitation will likely limit the number of individual, trust, closely-held C corporations and personal service corporation taxpayers that choose to engage in the purchase of clean energy credits.
Does the transferor need to register with the IRS before transferring the credit?
Yes, a taxpayer that wishes to transfer all or a portion of their clean energy credits must obtain a registration number by entering into a pre-filing registration process with the IRS for each qualified investment.
Temporary regulations require that the taxpayer:
1. complete the pre-filing registration process electronically through an IRS electronic portal
2. receive a registration number prior to making a transfer election for a specified credit portion on the eligible taxpayer’s return for the taxable year at issue
3. obtain a registration number for each eligible credit property with respect to which a transfer election of a specified credit portion is made
4. provide specific information about the taxpayer, about the eligible credits, and about the eligible credit property
Registration numbers are valid for an eligible taxpayer only for the taxable year for which it is obtained, and for a transferee taxpayer’s taxable year in which the specified credit portion is taken into account.
Many were surprised that the request for specific information would have to be transferred to both the IRS and the purchasers of the credits.
What type of documentation must the transferee receive from the transferor?
The regulations require that the minimum amount of documentation be provided to the transferee, including:
· Information that validates the existence of the eligible credit property, which could include evidence prepared by a third party;
· If applicable, documentation substantiating that the eligible taxpayer has satisfied the requirements to include any bonus credit amounts in the eligible credit that was part of the transferred specified credit portion; and
· Evidence of the eligible taxpayer’s qualifying costs in the case of a transfer of an eligible credit that is part of the investment credit or the amount of qualifying production activities and sales amounts, as relevant, in the case of a transfer of an eligible credit that is a production credit.
What type of compliance must be followed to have a qualified transfer?
A transfer election must be made on an original return, no later than the extended due date, for the taxable year in which the eligible credit is determined. A transfer election cannot be made on an amended return or an administrative adjustment.
Both the transferor and transferee must attach a transfer election statement to their respective returns, which is signed under penalties of perjury. The information required on the election statement includes:
1. Name, address, and taxpayer identification number of the transferee taxpayer and the eligible taxpayer.
2. A statement that provides the necessary information and amounts to allow the transferee taxpayer to take into account the specified credit portion with respect to the eligible credit property, including
o A description of the eligible credit, the total amount of the credit determined with respect to the eligible credit property, and the amount of the specified credit portion
o The taxable year of the eligible taxpayer and the first taxable year in which the specified credit portion will be taken into account by the transferee taxpayer
o The amount(s) of the cash consideration and date(s) on which paid by the transferee taxpayer; and
o The registration number related to the eligible credit property
o Attestation that the eligible taxpayer is not related to the transferee taxpayer
o A statement or representation from the eligible taxpayer and the transferee taxpayer acknowledging the notification of recapture requirements
o A statement or representation from the eligible taxpayer that the eligible taxpayer has provided the required minimum documentation.
The regulations surrounding the transferability of clean energy credits is robust, and most likely will not become any easier. The proposed regulations provide businesses and tax professionals a spring board on how these 2023 credits can be monetized. Finger cross the IRS portal for registration numbers will be created quickly and required information request will be reasonable. Happy planning!