Federal Tax Credits
For Renewable Energy:
The U.S. Department of the Treasury (IRS) recently released proposed regulations to provide guidance on the transfer of certain federal income tax credits (“Credits”) derived from investments in renewable energy projects through sales.
The proposed regulations consist of regulatory sections 1.6418-1 through 1.6418-5 and a temporary regulation section 1.6418-4T. They are designed to implement the requirements of Section 6418 of the Internal Revenue Code of 1986, as amended by the Inflation Reduction Act of 2022. Section 6418 authorizes taxpayers to freely transfer specific federal income tax credits generated by investments in certain renewable energy projects. These proposed regulations were published in the Federal Register on June 21, 2023, and the deadline for submitting comments on them is August 14, 2023. These proposed regulations are currently in effect.
The key points of the regulations regarding the sale of federal renewable energy tax credits and the tax credits themselves are as follows:
Who Can Sell and Buy Tax Credits?
- Sellers can be any “eligible taxpayer,” which includes anyone subject to federal income tax, except those eligible for a “direct pay” election, like tax-exempt organizations, states, Indian tribal governments, etc.
- Note that sellers who are not generally subject to federal income tax and located in U.S. Territories, such as Puerto Rico, may be eligible to obtain (and sell, or use) Credits by following specific IRS guidelines.
- Buyers, known as “transferee taxpayers,” can be partnerships, corporations, individuals, trusts, or similar entities.
Eligible Renewable Energy Projects:
- Only specific federal income tax credits, referred to as “eligible credits,” derived from particular renewable energy projects, can be sold. Other federal income tax credits are not transferable.
When Can Tax Credits Be Sold?
- Credits can be sold for taxable years beginning after December 31, 2022.
How Are Tax Credits Sold?
- Credit sales typically involve purchase agreements, indemnity or guarantee agreements, and insurance coverage for specified recapture events. Sellers must also provide transactional diligence related to the project generating the Credits.
- Sellers must register with the IRS before selling Credits, and they receive a unique Registration Number for each “eligible credit property” they intend to transfer Credits for.
- A “transfer election statement” must be completed, and it includes information about both the seller and buyer, details about the transfer, and a statement about recapture requirements.
Other Sale Considerations and Limitations:
- Credit sales must be paid in cash (U.S. dollars).
- Credits cannot be sold for progress expenditures.
- Credits can only be sold once.
- Excessive Credit transfer results in tax liability for the buyer.
Recapture:
- Recapture applies to investment tax Credits but not to production tax Credits, with exceptions for carbon sequestration Credits.
- Recapture occurs if the seller disposes of the project within the recapture period, making the buyer liable.
- Indemnities and insurance coverage may be used to protect against recapture.
Excessive Tax Credit Transfer:
- Buyers are liable for excessive Credit transfer, which occurs if they claim more Credits than the seller is eligible for.
- There is a 20% penalty for excessive Credit transfer unless reasonable cause is demonstrated.
Anti-Abuse:
- The regulations include an anti-abuse provision that allows the IRS to disallow Credit transfers or recharacterize income tax consequences in cases where parties engage in transactions to avoid tax liability beyond the intent of Section 6418.
It’s important for sellers and buyers to carefully follow these regulations and consider the tax implications when selling or purchasing federal renewable energy tax credits.