Initial Takeaways on New IRS Guidance for the Transfer of Certain Tax Credits
By Bryen Alperin, Managing Director
The Inflation Reduction Act (IRA) brought significant changes to the landscape of renewable energy tax credits by introducing the option of transferability. This provision allows taxpayers to transfer their renewable energy tax credits to non-related parties, creating a new avenue for accessing the benefits of clean energy investments. The IRA’s transferability provision has the potential to enhance liquidity in the renewable energy sector, attract more private capital, and accelerate the transition to a sustainable future.
The IRS has now issued highly anticipated proposed regulations for the transfer of certain Federal income tax credits under Section 6418. These regulations provide much needed guidance to taxpayers who intend to make an election to transfer eligible credits as well as transferee taxpayers as to the treatment of transferred eligible credits.
Clearer Guidelines for Tax Credit Transfer
These proposed regulations would allow eligible taxpayers to transfer any specified portion of an eligible credit determined with respect to any eligible credit property to a transferee taxpayer in accordance with Section 6418 of the Code and §§1.6418-1 through 1.6418-5. The regulations also provide definitions for terms used throughout the section 6418 regulations, including that of an eligible taxpayer.
Along with needed definitions, the time and manner to make a transfer election, and information about the pre-filing registration process, among other items have also been outlined in the proposed regulations. The Treasury Department and the IRS intend and expect that providing taxpayers with guidance that allows them to effectively use section 6418 to transfer eligible credits will beneficially impact various industries, deliver benefits across the economy, and reduce economy-wide greenhouse gas emissions.
Based on the proposed regulations, eligible taxpayers are also required to provide certain required minimum documentation to the transferee taxpayer, and the transferee taxpayer is required to retain the documentation for as long as it may be relevant. Many of the other requirements, such as completing the relevant source credit form and completing the Form 3800, would be required for any taxpayer that is claiming a general business credit, regardless of whether the taxpayer was transferring the credit under section 6418.
While the Treasury Department and the IRS do not have sufficient data to determine precisely the likely extent of the increased costs of compliance, the estimated burden of complying with the recordkeeping and reporting requirements are described in the Paperwork Reduction Act section of the preamble.
Overall, these proposed regulations provide much-needed guidance for taxpayers who wish to transfer eligible credits and for transferee taxpayers who receive transferred credits. The regulations will help to streamline the transfer process and ensure that all parties involved are aware of their obligations and responsibilities.
Key Initial Takeaways
Recapture Risk: The recapture risk for change of ownership stays with the seller, not the buyer of the tax credits. This means that a change in ownership of a partnership or S corporation that transfers a tax credit does not cause recapture for the buyer of the credit. This is a significant development. However, this is true only for recaptures that are from seller partner transfers, not seller asset transfers. If the tax credit buyer negotiates for the seller’s lender to foreclose only by taking over the seller partner interests, they could structurally mitigate recapture by reason of foreclosure.
Payment for Transfer Credits: Payment for transfer credits has to be in cash and needs to happen before the filing date of the tax return. This new rule eliminates the idea of paying for an Investment Tax Credit (ITC) over time during the recapture period, a structure that had been explored for mitigating recapture risk for buyers of ITCs.
Transfer Requirements: To transfer a credit, you need to file the following:
- Properly completed relevant source credit form for the eligible credit (e.g., Form 7207)
- Properly completed Form 3800, General Business Credit
- Schedule attached to the Form 3800 showing the amount of eligible credit transferred for each eligible credit property
- Transfer election statement, which at minimum, must include:
- Name, address, and taxpayer identification number of transferor and transferee taxpayers
- Statement that provides necessary information and amounts to allow the transferee taxpayer to take into account the specified credit portion with respect to eligible credit property
- Any other information related to the election specified in guidance
- Due date and original return requirement of a transfer election
Taxable Years: To the extent the taxable years of a transferor and a transferee taxpayer end on different dates, the transferee taxpayer will take the specified credit portion into account in the transferee taxpayer’s first taxable year that ends after the taxable year of the transferor taxpayer.
Tax Treatment of Proceeds: The proceeds from the sale of credits are tax-exempt. This was already expected, but a good confirmation, as it will reduce the cost of capital going into renewables and decarbonization by narrowing the spread between buyers’ bids and sellers’ asks.
Transferee Taxpayer Income: A transferee taxpayer does not have gross income when claiming a transferred specified credit portion, even if the amount of cash paid to the eligible taxpayer was less than the amount of the transferred specified credit portion.
Pro Rata Transfer Only: The only portion of the credit you can transfer is pro rata portion of the whole. No slicing off bonus credits, or other interesting portions of the credit. Some industry participants had hoped for more flexibility in how a transfer is structured, but most of the industry was expecting that the requirement would be a pro rata transfer. This aspect of the guidance is perhaps a bit disappointing, but not a surprise.
Pre-Registration Process: The proposed regulations require the transferor to register the credits online before filing the election. This digital tracking of credits by the IRS is designed to ensure transparency and prevent multiple transfers of the same credits. Based on conversations with insiders, Foss expects the pre-registration portal to be active near the end of 2023.
Advanced Commitments: The regulations allow for advanced commitments to purchase eligible credits. As long as all cash payments are made within the specified period, this provision can help bridge the timing gap between the payoff of construction loans and proceeds being received by buyers.
Intermediaries and Partnerships: The guidance confirms that intermediaries can support transactions without violating the ‘no second transfer’ rule. Also, partnerships or S corporations may qualify as eligible taxpayers or transferee taxpayers, opening up more possibilities for structuring transactions.
Active/Passive Rules: The guidance suggests that active/passive rules are expected to apply, but further comments are requested. This will likely limit the expansion of the transferable tax credit market, as it will be difficult for individuals to qualify for these tax credits.
Base and Bonus Credits: The guidance specifies that base and bonus credits can’t be sold separately. This could present complications for developers who may reach certainty about eligible bonus amounts later in the process.
Dealer Arrangements vs Broker Arrangements: The guidance confirms that dealer arrangements are not permissible (i.e., a dealer have a brief ownership interest in the credit) , while broker arrangements are. This distinction will be important for financial institutions, syndicators, intermediaries, and platforms involved in the transfer of tax credits.
In conclusion, these proposed regulations provide much-needed guidance for taxpayers who wish to transfer eligible credits and for transferee taxpayers who receive transferred credits. The regulations aim to streamline the transfer process and ensure that all parties involved are aware of their obligations and responsibilities. As we navigate these new regulations together, we hope this guide serves as a valuable resource for understanding and implementing the Section 6418 transfer of certain credits.
Additional Resources
The transferability of renewable energy tax credits offers flexibility and benefits to both investors and renewable energy projects, allowing taxpayers to access credits without ongoing ownership, which can diversify their investment portfolios and provide a source of funding for renewable energy projects. To learn the basics of transferability, read our blog, What Do We Know About the Transferability of Renewable Energy Tax Credits?
Once you gain an understanding of the basics, learn about what opportunities are available to your company. For more information read our blog, Opportunities in the Transferability of Renewable Energy Tax Credits. The blog delves into the wider implications of transferability, demonstrating how it benefits not only investors but also extends to renewable energy projects themselves by opening the pool of potential investors, which can ultimately accelerate the transition to net zero.
To learn about factors investors and developers should consider like tax credit “step ups,” monetizing depreciation, and recapture risk for transferable tax credits, read our blog Maximizing Benefits: How to Make the Most of Transferable Tax Credits.
If you are interested in any aspect of tax credit investing, we recommend reaching out to tax credit professionals for expert assistance and support. Take the first step towards your tax credit investment goals by contacting Foss & Company today.
