On June 14, 2023, the Internal Revenue Service (the “IRS”) and the Department of the Treasury (“Treasury”) released a package of proposed regulations including Section 6417 Elective Payment of Applicable Credits and Section 6418 Transfer of Certain Credits (the “proposed regulations”). The proposed regulations provide guidance regarding the direct pay election and the transfer election (both available for tax years beginning after December 31, 2022) for certain clean energy tax credits as established by the Inflation Reduction Act of 2022 (the “Inflation Reduction Act”) and designed to facilitate monetization of tax credits by persons that cannot otherwise use the tax credits against their tax liability.
The proposed regulations are generally proposed to be effective for taxable years ending on or after the date final regulations are published in the Federal Register, although taxpayers may rely on them prior to such time (for tax years beginning in 2023), provided the taxpayers follow the proposed regulations in their entirety and in a consistent manner.
Comments on the proposed regulations are due by August 14, 2023, and a public hearing on the proposed regulations under Section 6417 is scheduled for August 21, and on the proposed regulations under Section 6418 on August 23.
Highlights of Proposed Rules
- Registration and Transfer Requirements. The proposed regulations condition the transfer and direct pay elections on new information reporting and registration requirements, including extensive rules requiring eligible transferor taxpayers to register the credits with the IRS through an electronic portal, receive a registration number for each credit, and use that registration number in connection with all transfer and direct pay documentation and filings.
- Prohibition of Successive Transfers. The proposed regulations do not permit successive transfers of the same credit or a direct pay election with respect to a credit that has been transferred. For example, a Section 45Q credit that has been transferred to the taxpayer pursuant to an election under Section 45Q(f)(3)(B), or a credit acquired by a lessee from a lessor by means of an election to pass through the credit to a lessee under former Section 48(d), cannot be the subject of an election under Section 6417 to receive direct pay of the credit or under Section 6418 to make an additional transfer of the credit. And a credit that has been transferred under Section 6418 cannot be the subject of a Section 6417 direct pay election or another Section 6418 transfer.
Direct Pay Elections
- No Change to Direct Payment Timing. Despite requests from commenters, the proposed regulations offer no mechanism for receiving payment from the government pursuant to a direct pay election any earlier than upon return filing and refund payment. Moreover, the credit amount from a direct pay election is deemed to occur only upon the filing of the return, so (unlike a credit transferred under Section 6418) it cannot be used to reduce a taxpayer’s quarterly estimated tax payment obligation.
- Scope of Government Entities for Direct Pay Election. The proposed regulations clarify that applicable entities eligible to make the direct pay election include any agency or instrumentality of any State, the District of Columbia, Indian tribal government, U.S. territory, or political subdivision thereof, thereby including for example, certain universities, hospitals, school and water districts.
- Partnership vs. Tenancy-in-Common Ownership. Partnerships that include both applicable entities and non-applicable entities are not eligible to make a direct pay election. However, an applicable entity that owns credit property through a tenancy-in-common or joint operating arrangement may be considered to own an undivided interest in or share of the underlying property, thereby allowing a direct pay election for its interest or share.
- Passive Activity Credit Rules. The proposed regulations provide that rules that relate to the determination of the amount of a credit apply at the transferor level, while rules that determine the extent to which a taxpayer is entitled to use a credit apply at the transferee level. Under this approach, the passive activity credit rules will generally discourage purchases of credits by individuals and closely-held corporations. However, the IRS has requested comments on this topic.
- Recapture. The proposed regulations provide that any recapture liability would fall on the transferee of a credit under Section 6418 (e.g., if the transferor of an investment tax credit transfers the relevant energy property during the five-year recapture period). However, in the event of an indirect ownership change of a project (e.g., in the case of a transfer of an interest in a partnership that previously claimed and transferred a credit), the recapture liability would remain with the transferor.
- No Separate Transfers of Bonus Credits. The rules explain that bonus credits (e.g., the domestic content bonus credit, the bonus credits for projects in low-income communities or energy communities, and the 5x multiplier for compliance with the prevailing wage and apprenticeship requirements) cannot be transferred separately from the base credit amounts.
- Sale of Credit Allocable to Specific Partners. Even though the transfer election must be made at the partnership, and not the partner, level, the proposed rules allow transferor partnerships that are transferring only part of their credits to use special allocations to allocate the sales proceeds to those partners that want to participate in the sale while allocating the remaining credits to partners that do not want to participate in the sale, thereby effectively implementing the transfer on a partner-by-partner basis.
- No Gross Income for Discounted Purchase Price. There is no gross income to a transferee taxpayer if the amount paid for the credit is less than the amount of the credit transferred and claimed.
- Reasonable Cause Exception to Penalties. In order to avoid the penalty for excessive credit transfers, transferees may establish reasonable cause for their credit claim by pointing to extensive diligence inquiries of the transferor, including the transferor’s documentation evidencing eligibility for bonus credit amounts.
To read our full discussion of the proposed regulations please click here.
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