Sale of clean-energy credits: Traps for the unwary

Editor: Mo Bell-Jacobs, J.D.

The Inflation Reduction Act of 2022, P. L. 117-169, added new Sec. 6418 to the Internal Revenue Code, allowing eligible taxpayers to transfer (or sell) all or a specified portion of an eligible credit to an unrelated taxpayer in exchange for cash. The ability to sell a clean-energy credit for cash may be an attractive option for taxpayers for many reasons. The sale can expedite the economic benefit of the credit, allow taxpayers in a loss position to avoid credit carryforwards, or allow passthrough entities to keep the benefit at the entity level instead of passing credits to shareholders.

Alternatively, taxpayers may consider purchasing clean-energy credits to offset their federal income tax liability. Taxpayers must consider the rules in recently proposed regulations to determine if buying or selling a clean-energy credit is a good strategy for them. This item explores some of the traps unwary buyers and sellers could run into.

The election to sell a clean-energy credit is available for tax years beginning after Dec. 31, 2022. Eleven credits are transferable under Sec. 6418:

• Sec. 30C alternative fuel vehicle refueling property credit;
• Sec. 45 renewable electricity production credit;
• Sec. 45Q carbon oxide sequestration credit;
• Sec. 45U zero-emission nuclear power production credit;
• Sec. 45V clean hydrogen production credit;
• Sec. 45X advanced manufacturing production credit;
• Sec. 45Y clean electricity production credit;
• Sec. 45Z clean fuel production credit;
• Sec. 48 energy credit;
• Sec. 48C qualifying advanced energy project credit; and
• Sec. 48E clean electricity investment credit.

Traps for the unwary: Sellers

Determine the credit, consider its risk profile, and compile documentation: Clean-energy credits are calculated, or determined, similarly whether they are to be utilized or sold by a taxpayer. The basis in investment credit property or the units produced by production credit facilities, the appropriate credit rate, the eligibility for credit “gadders,” and more should be considered and documented. The compliance process requires some extra steps for credits that are to be sold, for a few reasons. In that case, sellers must consider the risk profile of their clean-energy project/ facility:

• Is the technology that generates the credit new?
• Is the credit itself new, or has it been around for years?

These factors may affect the price at which the credit is ultimately sold. Sellers may also seek a tax opinion to support their credit determination, offering a higher level of confidence for buyers. Additionally, tax insurance may be procured to insure against risks in the transaction.

Prior to any credit’s being transferred, the taxpayer must register the saleable credit with the IRS and receive an individual registration number for each eligible credit property included in the election. This involves furnishing details regarding the taxpayer, the targeted eligible credits, and the eligible credit project. After a review, the IRS will issue a registration number for each eligible credit property. This registration number must be renewed for each year in which the election will be made. This prefiling registration process will be completed through the IRA/CHIPS Pre-filing Registration Tool, an electronic portal opened in late 2023.

Elections, including the registration, to transfer or sell credits must be made prior to the due date (including extensions of time) for the return for which the eligible credit is determined. At the time the IRS opened the electronic portal, it also published IRS Publication 5884, Inflation Reduction Act (IRA) and CHIPS Act of 2022 (CHIPS) Pre-Filing Registration Tool User Guide and Instructions. As of this writing, Publication 5884 recommends that users of the prefiling registration portal submit registrations at least 120 days before the eligible taxpayer plans to file its tax return with a transfer election.

Proposed regulations (REG-101610-23) would require eligible taxpayers selling credits to furnish essential documentation to the transferee taxpayer. This includes proof affirming the existence of the eligible credit property, potentially supported by third-party documentation from entities such as a county board, governmental body, utility, or insurance provider. Additional documentation would be required where the amount of credit eligible for transfer is affected by bonus or addition requirements, including the prevailing wage and apprenticeship requirements, low-income communities bonus, domestic-content bonus, and the energy-communities bonus. Therefore, if applicable, the eligible taxpayer must provide documentation verifying satisfaction of requirements for bonus credit inclusion in the transferred specified credit portion. Evidence is also required of qualifying costs for investment credit transfers or qualifying production activities and sales amounts for production credit transfers.

Determine applicability of Sec. 49 at-risk rules: The amount of eligible credit that is transferrable is subject to Sec. 49 at-risk limitations. The proposed regulations under Sec. 6418 would limit the amount of credit that can be sold to the amount of credit that would be claimed by the seller taxpayer as if they were to use it themselves. In practice, sellers are prevented from selling more credit than they could otherwise use due to limitations such as those under Sec. 49 or 50. The at-risk limitations are applied with respect to the tax year in which the applicable credit is determined. Passthrough entities will need to consider these limitations at the partner or shareholder level when calculating the amount of the allowable credit. Credits transferred that are more than the allowable credit are subject to recapture and penalties.

Find a buyer or work with a broker: An emerging market for the sale of clean-energy credits has been developing since the enactment of the Inflation Reduction Act. Sellers may transact directly with buyers. Additionally, sellers may transfer portions of the credit to multiple buyers, opening the opportunity to more buyers seeking small to moderate credits.

Taxpayers that plan to transfer their credits can work with an emerging market of clean-energy-credit brokers to find potential buyers for the credit. Working with a broker is not required, and the IRS prefiling registration portal is not a brokerage service. Credit brokers typically charge a fee for brokering the credit and assist in facilitating the sale between the seller and the buyer.

Consider timing and the paid-incash requirement: Another potential blind spot sellers should take into consideration when thinking about transferring clean-energy credits is the “paid in cash” requirement under Sec. 6418(b)(1). This requirement dictates that U.S. dollars be paid in connection with the sale of an applicable credit via cash, check, cashier’s check, money order, wire transfer, Automated Clearing House transfer, or other bank transfers of immediately available funds. Any use of noncash consideration will invalidate the transfer. In addition to clarifying the cash-payment requirement, the proposed regulations provide that a payment is considered paid in cash if the transfer is made during the period beginning on the first day of the transferor’s tax year during which the transferred credit is determined and ending on the due date for completing a transfer election statement. Notably, once the transfer election statement is made, the election is irrevocable.

Traps for the unwary: Buyers Evaluate ability to use a credit: The passive activity loss and credit limitations under Sec. 469 will not affect the amount of credit eligible to be sold, but they may affect a buyer’s ability to use the credit. The proposed regulations treat all credits in the hands of a buyer as a passive activity credit. So, buyers subject to the passive activity limitations must have a tax liability attributable to passive income in order to use purchased clean-energy credits. Buyers will need to consider these limitations to understand the financial effect of purchasing a tax credit.

Plan for timing of credit use: Buyers also face timing considerations. First, the buyer cannot deduct any cash consideration it pays; conversely, any discount on the credit negotiated by the buyer is not taxable to the buyer. Second, the transferred credit is claimed in the buyer’s first tax year ending with or after the seller’s tax year for which the credit was determined. Note that the buyer cannot under any circumstance retransfer the credit.

Perform a due-diligence assessment: Due to the recapture risk and penalties for excess tax credits claimed, buyers should consider negotiating indemnification terms with the seller in case of recapture events or a challenge by the IRS, exploring insurance options to cover recapture risk, and conducting thorough due diligence. Buyers should assess whether the credit in question is transferable, the seller is eligible to determine and transfer the credit, and the seller has adhered to all necessary procedures for a valid transfer election. Not all credits that can be validly sold are equal. Buyers should consider their own risk tolerance and the risk profile of the credit to negotiate a fair price.

The buyer taxpayer must also retain documentation received from the eligible taxpayer for as long as its contents may be relevant in the administration of any IRS law. This is critical because Sec. 6418(a) treats the buyer as the taxpayer that determined the credit, meaning the buyer is responsible for recordkeeping and certain recapture events.

A crucial concern for taxpayers is obtaining clarity on tax credit recapture. For example, investment tax credits may face recapture if the associated asset is disposed of or ceases to be eligible property within a five-year recapture period. Another recapture example is a recapture of a tax credit under Sec. 45Q, which occurs if the sequestered CO. Leaks from underground storage within a three-year period. Sec. 6418(g) specifies that the transferor must notify the transferee of a recapture event, and the transferee must acknowledge and address the recapture, repaying the IRS as necessary. Sellers may have control over a recapture event, but it is the buyer that would have to pay back a recaptured credit.

Incentivizing clean-energy projects

Despite the risks and complexities of buying and selling tax credits, the new transfer election under Sec. 6418 can be useful to taxpayers in a variety of situations. The election may even encourage taxpayers to pursue clean-energy projects they may have otherwise delayed due to their inability to fully use any resulting income tax credits. Taxpayers seeking to buy or sell clean-energy credits should consult with their tax adviser to avoid traps for the unwary.

Editor Notes

Mo Bell-Jacobs, J.D., is a senior manager with RSM US LLP.

For additional information about these items, contact the author(s) of this item: Deborah Gordon, J.D., LL.M. (Deborah.Gordon@rsmus.com); Brent Sabot, CPA, MST (Brent.Sabot@rsmus.com); Eugene Boakye, J.D., LL.M. (Eugene.Boakye@rsmus.com); Heather Rosas (Heather.Rosas@rsmus.com); and Leo Rich, CPA (Leo.Rich@rsmus.com), Washington, D.C..

Contributors are members of or associated with RSM US LLP.