The IRS issued final regulations regarding the transferability of energy tax credits under the Inflation Reduction Act (IRA) on April 25, 2024. This article discusses the transferability of energy tax credits under the final regulations.

Section 6418 of the Internal Revenue Code (the Code) authorizes eligible taxpayers to elect to transfer (i.e., sell) all or any portion of an eligible credit in any eligible tax year. The credit may only be transferred to a taxpayer unrelated to the eligible taxpayer. An eligible taxpayer is defined in the final regulations as any taxpayer that is not an applicable entity under Section 6417(d)(1)(A). Therefore, entities exempt from federal income tax, such as state and local governments, not-for-profit corporations and other specified entities, cannot transfer eligible credits.

The 11 energy credits that are eligible credits for an election to transfer include the following:

1. Credits for alternative fuel vehicle refueling property (Section 30C);
 
2. Renewable electricity production credit (Section 45);
 
3. Credit for carbon dioxide sequestration (Section >45Q);
 
4. Zero-emission nuclear power production credit (Section 45U);
 
5. Clean hydrogen production credit (Section 45V);
 
6. Advanced manufacturing production credit (Section 45X);
 
7. Clean energy production credit (Section 45Y);
 
8. Clean fuel production credit (Section 45Z);
 
9. Energy investment tax credit (Section 48);
 
10. Qualifying advanced energy project credit (Section 48C); and
 
11. Clean electricity investment credit (Section 48E).

Under Section 6418(b), all consideration paid by the transferee taxpayer for transferring the eligible credit must be paid in cash. The consideration the eligible taxpayer receives is not included in their gross income, as the payment is treated as tax-exempt income. The transferee taxpayer cannot deduct the amount of consideration paid for the credit transfer, similar to a payment for federal taxes. The transferability section of the IRA is tax neutral. The primary target of the IRA transferability provisions is for publicly held and larger privately held C corporations, which are typically not subject to the passive activity rules under Section 469.

The eligible taxpayer must make a transfer election on its original timely filed tax return for the tax year in which the eligible credit is determined to be placed into service. This means the transfer election must be made by the due date of the eligible taxpayer’s original tax return, including extensions. The transfer election can’t be made on an amended return. A transfer election cannot be revoked after the eligible taxpayer has made it. Also, the eligible taxpayer wanting to make a transfer election must complete the IRS online pre-filing registration process and receive a registration number from the IRS for the eligible credit property. The seller and developer must undergo the same registration process with the IRS. This registration system is intended to avoid duplication of projects and discourage fraud. See the IRS registration site for more information.

The transferee taxpayer must receive the registration number for the eligible credit property and additional supporting documentation specific to the eligible credit from the taxpayer to claim the transferred credit on its tax return.

Required supporting documentation includes:

• Proof of the eligible credit property's existence.
• Confirmation that the eligible taxpayer met the requirements for any bonus credit amounts, such as prevailing wage and apprenticeship bonus and domestic content bonus.
• Evidence of the eligible taxpayer’s qualifying costs for the eligible credit property.

The eligible transferor and transferee taxpayers must also complete a transfer election statement and attach it to their tax returns.

The statement must include information, including:

• Names, addresses and taxpayer identification numbers for both the eligible transferor taxpayer and the transferee taxpayer
• Description of the credit being transferred
• Tax years involved
• Payment details
• Specific representations per the regulations

The final regulations state that the transferee taxpayer is liable for recapturing the credits received through a transfer. Recapture applies to investment tax credits such as those under Sections 48, 48E or 48C. It does not apply to production tax credits (except for the carbon sequestration credit under Section 45Q, which has a three-year recapture period). If a recapture event occurs, the transferee taxpayer must recapture an amount of previously claimed tax credits based on the timing and amount of the recapture event. However, recapture liability applies proportionately to an eligible taxpayer and any transferee taxpayers to the extent an eligible taxpayer has retained eligible credits. A recapture event occurs if the qualifying energy asset is disposed of, sold, or ceases operations within the first five years after being placed in service. However, if a disposition of an ownership interest in the eligible taxpayer occurs, the owner of such interest, not the transferee taxpayer, is liable for the recapture.

If a recapture event occurs, the eligible taxpayer must notify the transferee taxpayer. Then, the transferee taxpayer must inform the eligible taxpayer of any recapture amount. These notices must be exchanged before the due date of the eligible taxpayer's and transferee taxpayer's federal income tax returns without being extended. The exchange time must be enough for the transferee taxpayer to calculate the recapture amount and the eligible taxpayer to calculate any increase in the tax basis of the qualified energy property resulting from the recapture before their respective returns are due.

In addition to recapture, a transferee taxpayer is liable for any excessive credit transfer. An excessive credit transfer occurs when a transferee taxpayer claims more credits than are otherwise allowable to the eligible taxpayer for the eligible credit property. In such an event, the transferee taxpayer will be required to pay the IRS a tax equal to the excess amount of the credit claimed plus 20% of the excess amount. The final regulations provide that a recapture event is not an excessive credit transfer, so the excessive credit transfer rules operate independently of the recapture rules. If a transferee taxpayer can show reasonable cause for an excessive credit transfer, the 20% penalty may be removed by the IRS. However, under the IRA, a transferee taxpayer can carryback any unused transferred credits for three tax years, potentially freeing up prior year taxes paid. Since these are general business credits, they are subject to a 75% one utilization limitation for any tax year.

Many property and casualty insurance companies are entering this space to provide tax credit insurance to mitigate recapture risk, ITC valuation risk, bonus credit exposure and other credit transfer tax risks. Tax credit insurance may not be available for smaller transfers. In these situations, the parties may need to rely more on tax due diligence, guarantees, representations and warranties to manage the potential tax and transaction risks.

The final regulations allow the IRS to disallow the transfer of an eligible credit or to recharacterize the income tax consequences of a transfer transaction. This may occur when parties to a transfer transaction have engaged in one or more transactions to avoid tax liability beyond the intent of Section 6418. Eligible and transferee taxpayers must carefully separate the economic consideration of the credit transfers from other activities between the parties that produce income.

The new transferability of energy tax credits is a helpful tool for entities that previously would not or could not have entertained tax equity deals. We believe the transferability market will be $50B in 2025 and $75B to $100B in 2026, with further increases beyond. To claim these benefits, the eligible and transferee taxpayers must comply with many rules. Our renewable energy team can assist eligible clients.

Connect with our team to learn more.