IRS declines to relax energy credit transfer rules


The IRS on April 25 released final regulations (TD 9993) on energy credit transfers that largely reject taxpayer recommendations to ease restrictions. The final regulations do provide helpful clarity in some areas, but retain the most significant restrictions and will complicate transactions and create risk.


The Inflation Reduction Act (IRA) established new mechanisms for taxpayers to monetize energy credits, including allowing 11 credits to be sold and transferred to other taxpayers for cash. The IRA also allows three of the credits to be claimed as refundable payments for five years and for certain tax-exempt entities to claim all of them as refundable (see our prior story for the refundability rules).


The most significant limitations retained in the final regulations include the following:

  • The rules impose strict time limits on when buyers can remit payment for the credits, limiting the ability for sellers to use transfers for upfront financing and potentially complicating project structuring.
  • Purchased credits will be subject to the passive activity limitations under Section 469, limiting their appeal to individuals.
  • Taxpayers cannot segregate different portions of a credit to sell (such as bonus credit amounts), limiting flexibility and marketability.
  • Partnerships and S corporations transferring energy credits will be limited to amounts considered “at-risk” to their partners and shareholders under Section 49.

Like the proposed rules, the final regulations make clear that purchasers of credits will retain significant risk. The transferee essentially becomes the taxpayer for purposes of the credit and will be liable for any recapture or any adjustment after an exam. Adjustments will also incur a 20% penalty unless there is reasonable cause for the excess credit amount.


The final regulations are generally applicable for tax years ending on or after the date they are published in the Federal Register, but taxpayers can rely on the bulk of the rules in prior years provided they rely on them in their entirety and in a consistent manner.


Grant Thornton Insight

The IRS registration portal is open, and guidance is available on the reporting requirements for transfers. There is already a robust transfer market largely facilitated by brokers. The transactions can be complex, however, and taxpayers should understand the rules and explore all their options for financing projects and monetizing credits. Most transfer transactions will require some combination of indemnification clauses or other contractual protections, tax insurance, specific documentation backing the credits, and written advice on any technical issues. 






The IRA provides that taxpayers can elect to transfer any of the following credits:

  • Section 45 production tax credit (and the Section 45Y credit that will replace it 2025)
  • Section 48 investment tax credit (and the Section 48E credit that will replace it 2025)
  • Section 45U nuclear power credit
  • Section 48C advanced energy property credit
  • Section 45Q carbon oxide sequestration
  • Section 45V hydrogen production credit
  • Section 45X advanced manufacturing credit
  • Section 30C alternative fuel refueling property credit
  • Section 45Z clean fuel production credit that will take effect in 2025

An eligible taxpayer for purposes of making a transfer election is defined in Section 7701(a)(14), which generally includes “any person subject to any internal revenue tax.” This includes entities with U.S. employment or excise tax obligations even if they do not have income tax obligations. The IRS rejected comments asking for the definition of eligible taxpayer to be expanded to include taxpayers in U.S. territories without an internal revenue tax obligation. The IRS also declined to provide an exception from the general credit rules under Section 50(b)(1), which can limit credits for property used in U.S. territories.


Taxpayers can only elect to transfer credits if they are sold solely for cash considerations to an unrelated party. The cash is excluded from the gross income of the seller and is not deductible by the buyer. Taxpayers must register to make the transfer election (discussed more below). The election is made on the annual return for which the credit is determined and must be made by the due date of that return (including extensions). The final regulations provide that the election can also be made on a superseding return. The election is not revocable, and the IRS declined to offer 9100 relief for missed elections, though certain computational errors can be fixed on an amended return.


Taxpayers cannot elect to transfer a carryforward or carryback credit, though the transferee can use the purchased credit as a carryback or carryforward. The transferee must take the credit into account in the first taxable year ending with or after the tax year the seller transfers the credit.


A credit can only be transferred once. In addition, a credit that has already been assigned to another taxpayer under another provision in the code, such as a lessee under Section 50 or an assignee under Section 45Q, cannot be transferred. 


Grant Thornton Insight

The inability to deal or trade in credits will curb any speculative market. Brokers are allowed to facilitate transfers if they are not themselves buying and selling the credits, but if the credit itself is subject to an IRS transferred transaction, it cannot be transferred again or claimed as a refundable payment under Section 6417.




Cash considerations


Credits are transferrable only if all consideration for the credit is “paid in cash.” The final regulations retain a narrow definition of “paid in cash,” which includes only U.S. dollars transferred by cash, check, cashier’s check, money order, wire transfer, ACH transfer or other bank transfer of immediately available funds. More importantly, the final regulations restrict when the payment can be made to the time period between the first day of the tax year in which the credit arises and the due date for making the transfer election. Taxpayers can enter into contractual agreements to transfer credits earlier, but the cash must be exchanged during this period.


Grant Thornton Insight

The strict interpretation of the “paid in cash” requirement will limit the ability of taxpayers to make credit transfers as part of broader transactions or arrangements unless the parties can establish that any credit transfer is separately made solely for a qualifying cash payment. The restrictions on when the payment can be made, which is a rule wholly created by the IRS and is not in the statute itself, will hamper the ability of taxpayers to use a credit transfer to obtain upfront financing. The IRS received many comments on this issue, but said that expanding the time frame would create too many administrative challenges. The preamble notes that taxpayers can potentially use future purchase agreements to secure financing, but the IRS declined to offer any guidance or safe harbors for determining when these arrangements would be respected as loans or recharacterized as upfront payments for credits. 




Qualifying credits


The rules generally require taxpayers to make separate elections for each eligible credit property. For a production tax credit, this means the election must be made separately for each facility and for each taxable year. For an investment tax credit, the final regulations rely on existing definitions to determine what is considered a single item of property.


Taxpayers can choose to transfer only a portion of any specified credit and retain the rest. Taxpayers can also elect to transfer separate portions of a single specified credit to multiple different buyers. Taxpayers cannot, however, separately identify and sell different aspects of a credit arising from a single property or facility. The credits generally provide a base amount and then offer bonus rates for meeting certain requirements, such as prevailing wage and apprenticeship rules, energy communities, and domestic sourcing. Transferees receiving only a portion of a credit will be deemed to receive a proportionate share of any base and bonus credit amounts.


Grant Thornton Insight

Many comments pushed the IRS to allow taxpayers to specifically identify and separately sell different aspects of a credit, such as the bonus and base amounts. This would potentially increase flexibility and marketability of credits and allow transactions to better allocate risks among buyers. The IRS declined to offer any flexibility, arguing that its interpretation more accurately reflects the intent of the statute and avoids administrative problems. The IRS’s approach, however, could complicate their own examinations. The fact that credits for a single project can be sold to multiple buyers could make IRS efforts to audit a project more difficult as any adjustment in the qualifying credit would potentially need to be made across multiple taxpayers in proportionate amounts. 




Credit limits


The final regulations are largely consistent with the way the proposed rules addressed how various limits on credits affect both buyers and sellers. The IRS drew a distinction between rules that impact the credit base and those that impact the ability of a taxpayer to claim a credit against liability. The amount of investment tax credit that a partnership or an S corporation can transfer is limited by any reduction in the credit base at the partner or shareholder level under the Section 49 at-risk rules. But the amount of credit that can be transferred is not affected by Section 469 passive-activity rules.


The transferee buying the credit, however, will be subject to the passive-activity rules. The credit will be considered a passive-activity credit and the taxpayer will not be able to change the characterization. The credits will also be subject to the general business credit limitations under Section 38. 


Grant Thornton Insight

The IRS largely resisted comments pushing to remove the automatic passive characterization for individual buyers. The final version makes one exception for a purchaser that owns an interest in the trade or business that generated the credit, though it’s worth noting that a credit cannot be transferred to a taxpayer considered a related party under Sections 267(b) or 707(b)(1). The ability to use the credits only against passive tax liability will limit the appeal to individual taxpayers.




Income tax considerations


The statute explicitly excludes the cash consideration received by the seller from gross income and disallows any deduction to the buyer. The proposed regulations also clarify that the buyer does not have any gross income or gain for federal tax purposes when claiming a purchased credit even if the taxpayer has paid less than the amount of credit. The basis reduction required for claiming investment tax credits must be performed by the seller of the credit who retains and depreciates the property, not the buyer of the credit.


The final regulations declined to address the tax treatment of any transaction costs for either the buyer or seller, such as legal and consulting fees, success-based fees, tax insurance or indemnity payments. The IRS requested comments on these issues when they issued the proposed rules, but said in the preamble to the final regulations that they were beyond the scope of Section 6418. The IRS said it anticipates issuing future guidance on the issue under other code sections and applying other general tax principles.


Grant Thornton Insight

The preamble to the proposed regulations included a long discussion of transaction costs that seemed to indicate the IRS was considering disallowing any deduction or capitalization for transaction costs based on a principle of statutory construction holding that tax law should not be interpreted to create a double benefit absent a clear declaration of intent by Congress. The preamble to the final regulations offered no such hints on the IRS’s current thinking, and the IRS received a number of comments on these issues.




Partnerships and S corporations


There are many special rules for S corporations and partnerships. The election to transfer credits must be made at the entity level and cannot be made by a partner or shareholder for a credit flowing to them from the entity. The final regulations, however, offer a mechanism to achieve a similar result for partnerships. Under a special rule, partnerships transferring only a portion of a credit can allocate the remaining credit amounts to specific partners and allocate the tax-exempt income received in the transfer to other partners. 


Grant Thornton Insight

This special rule effectively allows individual partners who could not utilize the credit to sell their allocations at the entity level while other partners retain and use their own credit allocations.


Any refundable payment or cash for a transfer is treated as tax-exempt income for a partnership or S corporation under Sections 705 and 1366. Absent the special rule described above, the regulations generally require the tax-exempt income to be allocated to partners in the same proportion as the underlying credit would have been allocated. S corporations must allocate the tax-exempt income on a pro rata basis. The income is not treated as passive for purposes of Section 469. There are no restrictions in the statute or regulations for how an S corporation or partnership can use the cash proceeds or refundable credit.


Partnership and S corporations can also purchase the credits. For partnerships, the cash used to buy the credit is a nondeductible expenditure under Section 705(a)(2)(B). The partnership allocates the credits based on each partner’s distributive share of the nondeductible expenses. The distributive share of the nondeductible expense is determined by the partnership agreement or the partnership’s general allocation of nondeductible expenses. S corporations purchasing a credit treat the cash payment as a nondeductible expenditure under Section 1367(a)(2)(D) and must allocate it and the credit on a pro rata basis. 


Grant Thornton Insight

Although a pass-through is permitted to purchase credits that will then be allocated to partners or shareholders, it may be easier in many circumstances for partners or shareholders to purchase credits directly to avoid the complications of allocating and flowing the credit attributes out to owner. It appears that individuals receiving purchased credits through an S corporation or partnership will still face the same passive activity restrictions they would if purchasing the credit directly. 






There is significant risk borne by buyers of the credit. The statute and regulations make clear that the buyer of the credit is treated as the taxpayer for purposes of the credit. To that end, the statute requires the seller to provide the buyer “required minimum documentation,” presumably so the buyer can document and substantiate the credit under IRS scrutiny. The information must include:

  • Information that validates the existence of the property
  • Documentation substantiating any bonus credit amounts
  • Evidence of the eligible taxpayer’s qualifying costs or production activities

Any recapture of an investment tax credit due to a disposition of the property by the seller is paid by the buyer, but the regulations provide an exception to the recapture rules for dispositions due to a partner’s or shareholder’s disposition of an interest in the partnership or S corporation. The transferee is also generally liable for any recapture of a Section 45Q credit due to the release of sequestered carbon emissions. More importantly, the buyer is responsible for paying any adjustment of a credit amount upon examination by the IRS. These amounts are considered “excessive credit transfers” and incur a 20% additional tax. This tax does not apply if the taxpayer can establish reasonable cause.


The final regulations provide a list of factors that can demonstrate reasonable cause, with the “most important” being the extent of the buyer’s effort to determine that the amount transferred is no more than the amount of eligible credit. The regulations also list several other non-exclusive “circumstances that may indicate reasonable cause,” including:

  • Reviewing the seller’s records and documentation for bonus credit amounts
  • Reasonable reliance on third-party expert reports
  • Reasonable reliance on representations that total portions of credits transferred do not exceed the eligible credit
  • Reviewing public company audited financial statements

If portions of a credit are sold to multiple buyers, they are all considered a single buyer for determining if there was an excessive transfer. If there is an excessive transfer, the amount of additional liability is allocated proportionally between the buyers.


Grant Thornton Insight

The risk to buyers is an important driver for structuring and pricing transactions. The IRS registration process does not certify that a credit is valid. Unlike many credit transfer programs for states and territories, the IRS is not offering any pre-certification process that will protect buyers from future liability. Buyers should perform significant diligence and sellers bringing credits to the transfer market should develop robust support and documentation for the underlying credit, including technical analyses of any important tax determinations. Buyers and sellers will also have to agree on contractual protections such as indemnification clauses. Tax insurance is available to manage a variety of the risks and may also require documentation and support. 




Registration and reporting


Taxpayers electing to transfer a credit must register before making the election. The registration will take place electronically through an IRS portal. Taxpayers must obtain a registration number for each separate credit property and the registration number must be included on the return when the direct payment or transfer election is made. In general, a new registration number is required each year with regard to a property, but the IRS plans to offer procedures to renew them.


Registration cannot be completed earlier than the beginning of the tax year in which the credits will apply, and cannot be done before the underling property is placed in service. Registration must be completed prior to filing the return making the transfer election and the IRS recommends claimants attempt to register at least 120 days before the organization plans to file.


Grant Thornton Insight

Taxpayers are not required to register 120 days before filing the return but should consider registering as soon as possible because a transfer election cannot be made without a registration number. The IRS processing time for registration varies, and the IRS sometimes requests corrections, additions or clarifications. 


Taxpayers will need to go through several steps in order to register, including having the individual performing the registration process set up an account to verify identification. The preamble to the final regulations states that the final regulations do not restrict a taxpayer from authorizing a representative such as a tax professional from applying for a registration number, but information on the portal does not make it completely clear who is eligible for authorization. Setting up an account requires an attestation that the person is a corporate officer, partner, guardian, executor, receiver, administrator, trustee or individual other than the taxpayer with legal authority to execute the authorization on behalf of the taxpayer. That person, however, can then add delegates to the account.


Taxpayers will need to provide significant information through the registration portal, including:

  • Name, taxpayer identification number (TIN), entity type, tax year, and type of return
  • Information about subsidiaries included in a consolidated group of corporations
  • Type of credit and type of property
  • Physical location of property
  • Bank account information
  • Date construction began and was completed
  • Any joint ownership
  • Source of funds

In many cases, the IRS also wants documentation supporting the registration application, such as permits, certifications, or evidence of ownership. These requirements will vary depending on the type of credit and are detailed in an IRS publication.




Next steps


The enhanced energy credits and new monetization options under the IRA present enormous opportunities for taxpayers interested in energy projects. But the rules are complex, and taxpayers should assess various options for structuring, financing, and monetizing projects. Traditional tax equity financing structures may still be attractive for projects needing upfront funding, monetizing depreciation, or seeking a step-up in basis to fair market value. The new credit market for direct transfers will also provide a unique new tax savings opportunity for taxpayers who are not themselves pursuing energy projects. Potential credit buyers should carefully assess the potential risks and consider strategies to address them. Taxpayers involved in any aspect of the programs should expect IRS scrutiny. The last time the IRS offered grants in lieu of energy credits (the section 1603 program), it became a major focus for compliance efforts. The IRS currently has a special $60 billion funding allocation to help drive enforcement.


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