RELATED UPDATE: IRS Issues Guidance for Direct Payments of Energy Tax Credits (June 20, 2023)
The Inflation Reduction Act of 2022 created new opportunities both in renewed and brand-new energy tax credits. It also offered new methods through which these credits can be claimed, as a Section 6417 direct payment to eligible tax-exempt entities (Direct Pay) or through a section 6418 transfer of a credit from one taxpayer to another for cash payments (Transfer).
On June 14, 2023, the IRS and Treasury Department released a series of proposed and temporary regulations with technical details for how to elect for Direct Pay or Transfer, including a registration process designed to prevent fraud, duplication, and improper or excessive payments from occurring through these methods. Along with the regulations, the IRS also issued a series of FAQs together offering much-needed clarity for taxpayers seeking to make use of the Inflation Reduction Act’s expanded benefits for pursuing specified renewable energy and manufacturing activities.
(Note that proposed and temporary regulations were also issued for direct payment credits under Section 48D for the manufacture of semiconductors and semiconductor manufacturing equipment in the United States; however, that is outside the scope of this alert.)
Subject to a taxpayer’s substantive qualification, the following tax credits qualify for Transfer under the Inflation Reduction Act (IRA).
|Section 30C – Alternative Fuel/EV Charger Credit||Section 45X– Advance Manufacturing Production Credit|
|Section 45/45Y – Production Tax Credit|| Section 45Z – Clean Fuel Production Credit |
|Section 45Q – Tax Credit for Carbon Sequestration||Section 48/48E – Investment Tax Credit|
|Section 45U – Nuclear Power Production Credit|| Section 48C – Advanced Manufacturing Tax Credit |
|Section 45V – Clean Hydrogen Production Credit|
Proposed Regulations on Section 6418 Transfers
A broad class of taxpayers can choose to use a Section 6418 Transfer to monetize some or all of a tax credit. Eligible taxpayers under this statute include any entity that is subject to U.S. tax and is not part of the selected group of nontaxable entities that are eligible to claim Direct Pay for these credits (Transfer Eligible Taxpayers). The broad Transfer rules are that the TransferEligible Taxpayer must receive money in exchange for the credit or portion of the credit Transferred. The statute is clear that a Transfer Eligible Taxpayer can sell a portion of its earned credits instead of the full credit, but the proposed regulations clarify that this means selling a proportionate share of the entire credit claim and not only a certain qualifying part, like a bonus credit “adder” such as the 10% credit increase for domestic content. For example, if a Transfer Eligible Taxpayer claims a credit adder on a Section 45 production tax credit and sells only 50% of the credits generated that year, both the sold and retained credits will be reduced if the adder is denied upon audit.
- Cash Payments and Anti-Abuse Rules
Cash payments received for a Transfer are not considered income for the person transferring the credit and cannot be deducted by the person receiving the credit. The proposed regulations defined “paid in cash” to limit the payment to U.S. dollars, which can be made by cash, check, cashier’s check, money order, wire transfer, ACH transfer or other bank transfer of immediately available funds. They also provide a safe harbor timing rule that validates a payment if made within the period beginning on the first day of the Transfer Eligible Taxpayer’s taxable year during which a specified credit portion is determined and ending on the due date for completing a Transfer election (i.e., the original return filing date). A contract to purchase all credits by Transfer meets the paid-in-cash requirement if the payments are completed within this timing.
The IRS and Treasury included anti-abuse rules in the proposed regulations, applicable to multipurpose transactions. To address concerns that Transfer Eligible Taxpayers may include a tax credit Transfer to avoid recognizing income from another aspect of a transaction, the IRS has the right to disallow or recharacterize a transaction. For example, a Transfer Eligible Taxpayer enters into a combined transaction to Transfer $100 of tax credits and provide $20 of services to the transferee and characterizes this as a $100 Transfer and provision of free services. The IRS will recharacterize this as an $80 Transfer and taxable receipt of $20 in services income. The key takeaway from this is that the IRS will be scrutinizing to ensure that all pieces of a transaction consideration represent the fair value of each item exchanged.
- Multiple Transfer Rules
The proposed regulations clarify that a Transfer Eligible Taxpayer can make multiple elections to Transfer portions of a credit to multiple transferees. Section 6418 does not limit the number of transfer elections or number of transferee taxpayers; thus, the proposed regulations do not either. This is distinct from a transfer of a single credit (or portion of a credit) multiple times, which is disallowed by the statute and these proposed regulations under the “no second transfer” rule. The proposed regulations specify that allocations of purchased credits by a passthrough transferee, such as a partnership or S corporation, to its direct or indirect owners does not violate the no-second-transfer rule. Dealer arrangements are not specifically forbidden by the proposed regulations, but a dealer cannot take title to the credit as an intermediary at any point without violating this rule.
- Recapture Rules for Transferred Investment Credits
If applicable investment credit property (under Section 48, Section 48C or Section 48E) is disposed of, or otherwise ceases to be investment credit property with respect to the Transfer Eligible Taxpayer, before the close of the relevant recapture period, then notification requirements apply. The Transfer Eligible Taxpayer must notify the transferee taxpayer of a recapture event and the recapture amount, if any, in such form and manner as guidance may provide.
In general, the proposed regulations require the transferee taxpayer to bear the recapture tax associated with any Transfer of an eligible investment tax credit. This is because the statute provides for recapture when property ceases to be investment credit property with respect to the Transfer Eligible Taxpayer. However, if an indirect transfer by a partner or an S corporation shareholder causes a recapture event, the proposed regulations consider the passthrough entity to be the Transfer Eligible Taxpayer, and thus, the property ceases to be investment credit property with respect to the individual partner or shareholder, not the Transfer Eligible Taxpayer. Accordingly, the individual partner or shareholder retains the recapture cost in those events.
- Timing for Transfer Elections and the Transfer Election Statement
Transfer Eligible Taxpayers must register their transferred credits under the rules of the temporary regulations discussed below. Once registered, a Transfer election must be made with the Transfer Eligible Taxpayer’s tax return filing (or short-year filing), and will require (a) a properly completed relevant form for the eligible credit, (b) a properly completed Form 3800 for the General Business Credit, (c) a schedule showing the amount of credit transferred, (d) a transfer election statement between the Transfer Eligible Taxpayer and the transferee, and (e) any other information the IRS specifies. The transferee’s tax return (or short-year return) must similarly provide (a) a properly completed Form 3800 for the General Business Credit, (b) a transfer election statement between the Transfer Eligible Taxpayer and the transferee, and (c) any other information the IRS specifies. The due dates of the parties’ original returns can be extended, and original returns include a superseding return filed on or before the due date, but no relief will be granted for missed elections after a return due date.
The parties’ transfer election statement must be completed before either party files a tax return. It must meet certain minimum requirements, including identifying information about the parties and the credit amounts, representations that the parties are not related, acknowledging recapture rules in the proposed regulations, and minimum required documentation that validates the existence of the eligible credit property, any bonus credits amounts and the evidence of credit qualifications.
Temporary Regulations on Pre-Filing Registration for Transfers
Transfer eligibility is contingent upon the Transfer Eligible Taxpayer completing the specified filing process, obtaining a registration number from the government and reporting the registration number on the entity’s annual tax return. Completion of the pre-filing registration requirements and receipt of a registration number does not, by itself, mean that the taxpayer is eligible for a valid Transfer. Ultimately, eligibility is determined under the substantive technical rules granting the specific energy credit.
The broad pre-filing parameters are as follows:
- Those intending to elect a credit Transfer must file through an IRS‑provided electronic portal (to be established by fall 2023).
- The election cannot be made until the registration requirements have been completed and the IRS has issued a registration number.
- Each applicable credit-bearing property or activity must have its own registration number.
- The required identifying information must be provided before the registration will be processed by the IRS, including certain amendment and renewal requirements.
Unless modified in future guidance, these temporary regulations establish the definitive list of required identifying information. The pre-filing information that must be provided is as follows:
- General identifying information (name, address, taxpayer identification number and type of legal entity).
- IRS-prescribed eligibility information, to be provided in the portal instructions (such as entity information or information regarding the relevant exempt status).
- The entity’s tax year.
- The type of tax return normally filed, or normal non-filing status.
- The type of credit(s) being claimed or transferred.
- Details about the credit-eligible property or project, such as (a) property type, (b) physical location, (c) supporting documents on the construction or acquisition, (d) dates of beginning construction and placing in service, and (e) source of funding if an investment-related credit.
- The contact person with authority to bind the entity.
- A penalties-of-perjury statement.
- Any other information the IRS deems necessary to prevent fraud, duplication, and improper or excessive payments.
The pre-filing registration process allows for renewals and amendments, so a project owner or developer can apply for a registration number speculatively and adjust if the project is not completed as expected. Each registration number is valid for use with respect to the specific taxpayer or tax-exempt entity that received it, and it is valid for only one specific tax year. If the election is not made for the specified year, the recipient can renew the registration for a subsequent taxable year according to applicable instructions, including attesting that all the facts previously provided are still correct or updating any facts as needed. Similarly, if the recipient of the registration number changes, such as through an acquisition, the original recipient must amend the application and the new owner must separately submit a new registration.
Notice and Comment on the Proposed and Temporary Regulations
The proposed and temporary regulations will be published in the Federal Register on June 21, 2023.
The Section 6418 Transfer proposed regulations may be relied upon for taxable years beginning after Dec. 31, 2022, but are subject to a notice and comment period before they will be made final. Interested parties are requested to submit comments by Aug. 14, 2023.
The pre-filing temporary regulations (at TD 9975) are made immediately effective without notice and comment, distinct from the proposed regulations discussed above. The IRS and Treasury mindfully assert that these mechanical registration activities need to be in place before fall 2023 to permit filers to take advantage of the Transfer provisions for their 2023 tax years, and to allow the IRS to begin the process of reviewing information that will prevent duplicate, fraudulent, improper, or excessive transfers or payments. However, the IRS and Treasury will accept comments on these temporary regulations along with the proposed regulations and they will be considered before any final regulations are issued.