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Final Regulations Issued Regarding Transfers of Clean Energy Tax Credits

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On April 30, 2024, the Internal Revenue Service (the “IRS”) and the Department of the Treasury (“Treasury”) published final regulations regarding transfers of clean energy tax credits under section 6418 (the “final regulations”).  The transfer election is 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 is designed to facilitate the sale of tax credits by persons that cannot otherwise use the tax credits to reduce their tax liability.  In June 2023, IRS and Treasury released proposed and temporary regulations under Section 6418, which we discussed here.

The final regulations are applicable for taxable years ending on or after April 30, 2024, but taxpayers may generally rely on them for prior tax years if they are applied in their entirety and in a consistent manner. 

The final regulations generally adopt the proposed regulations with minimal changes, including the mandatory pre-filing registration process the transferring taxpayer must complete before the transfer of an eligible credit.

Only One Transfer Is Allowed 

The final regulations retain the rule prohibiting the transfer of a credit more than once, including the prohibition of a transfer election with respect to a section 45Q carbon capture credit that has been transferred under section 45Q(f)(3)(B).  This means that if a company that sequesters carbon dioxide has been compensated for its services by transfer of a credit to it from the carbon dioxide-emitting company that hired it, the sequestering company will then not be able to monetize the credit by selling it.

“Chaining” Issue Remains Unresolved

Multiple commenters with respect to the section 6418 proposed regulations, as well as with respect to the section 6417 (“direct pay”) proposed regulations, requested that taxpayers be allowed to transfer (sell) credits to tax-exempt organizations so that such organizations may then use their ability to make direct pay elections with respect to any type of clean energy tax credit to monetize such credits (referred to as “chaining”).  Permissibility of a sale followed by a direct pay election by the tax-exempt would likely expand the market for tax credits and encourage tax-exempt organizations, such as pension plans and endowments, to put their funds to work in the clean energy tax credit market.  However, in releasing the final section 6417 regulations and in this release of the final section 6418 regulations, Treasury has specifically not adopted commenters’ recommendation to allow chaining but instead has published Notice 2024-27, which requests comments on the situations in which a direct pay election should be allowed for credits purchased in transfers under section 6418.  The deadline for such comments is not until December 1, 2024, so we should not expect resolution of this issue until 2025.  

All Components of a Credit Must Be Transferred Together

The final regulations also retain the rule that a credit must be transferred in “vertical” slices that include a pro rata portion of all credit amounts determined with respect to a single eligible credit property, including bonus credit amounts.  This means that it is not possible to sell, for example, only the bonus credit without the base credit or only the base credit if the credit has a bonus component.  Commenters had asked for the flexibility to sell only a part of a credit, pointing out that there may be different marketability considerations with respect to the base and the bonus components as each component may present a different qualification risk level and due diligence demands.  The request was rejected on the basis that tracking the different components separately raised too many administrative issues for the IRS.  

“Paid in Cash” Requirement Means Sales Cannot Be Used to Finance Construction

The definition of “paid in cash” was adopted without change, despite several commenters recommending revisions to the proposed rule so that advanced payments could be made for eligible credits that will be determined in later taxable years.  Instead, just as was seen in the proposed regulations, payment may not be made prior to the start of the year for which the credit is determined. As a practical matter, this rule effectively precludes pre-construction sales of credits in order to finance construction since the payment can be received no earlier than the year in which the project is placed in service and most projects have multi-year construction schedules. 

Transferee Bears Recapture Risk

The final regulations retain the rule from the proposed regulations that the burden of ITC recapture falls on the transferee unless the recapture arises from a transfer of an interest in a partnership or S corporation seller of credits or a later decrease in “at risk” amount.  The final regulations provide additional rules to avoid recapture to the transferee to the extent prior recapture to the transferor or its owners would cause the same credit to be recaptured twice.

Application of Passive Credit Rules Finalized – Individuals Less Likely to Be Credit Buyers

The final regulations do not vary from the proposed regulations with respect to application of the passive credit rules to individuals and closely-held businesses.  Under these rules, in general, such taxpayers will not be able to use a purchased credit to offset their tax liability with respect to income from other sources as to which they are “active.”  In choosing to maintain this position in the final regulations, the IRS has reduced the universe of potential tax credit buyers. 

Original Returns, Please

The final regulations clarify that a transfer election filed by an electing taxpayer may be made or revised on a superseding return, but not on an amended return.  A superseding return is a return filed subsequently to an original return but before the due date, including extensions, for filing the return. The final regulations confirm that a transfer election may not be made on an amended return. However, a numerical error with respect to a properly claimed transfer election may be corrected on an amended return or by filing an administrative adjustment request (“AAR”).  The original return requirement applies only to the return of the transferor taxpayer.  The transferee taxpayer may account for a transferred credit on an amended return or AAR.  The final regulations provide specific guidance on what information must be on the original return and can be corrected on an amended return, including to amend the amount of the eligible credit reported. The eligible taxpayer must have made an error such that there is a substantive error to correct; an eligible taxpayer cannot correct a blank item, or an item described as being “available upon request.”

Normalization Rules

Several taxpayer comments to the proposed regulations asked that the final regulations clarify the application of section 50(d)(2) “normalization rules” to transferred ITCs.  The IRS and Treasury rejected the comment as outside the scope of regulations under section 6418, so the final regulations do not address the issue.  However, in the preamble to the final regulations the IRS and Treasury “clarified” that an eligible taxpayer is not subject to the normalization rules with respect to cash consideration paid by the transferee taxpayer—the result being that if, for example, a utility sells ITCs, neither the utility nor the purchaser is subject to the normalization rules on the portion of the credit sold to the transferee.  Any portion of an eligible credit that is not transferred remains subject to the normalization rules as applicable.

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We will continue to monitor the Inflation Reduction Act guidance initiatives from the IRS and Treasury and will provide further updates as guidance is released.  In the meantime, Baker Botts would be pleased to assist you in your analysis of the Inflation Reduction Act and other clean energy tax incentive matters.

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