The Internal Revenue Service (IRS) and Department of the Treasury (Treasury) recently issued regulatory packages and issued a set of frequently asked questions covering the transfer of certain credits by certain taxpayers (eligible taxpayer) in exchange for cash to monetize energy credits under the Inflation Reduction Act (IRA). The regulations include special rules and registration requirements taxpayers must follow to utilize a transfer election as well as clarifying definitions.
In an effort to expand the scope of taxpayers that can access the IRA’s energy credit regime, the Act’s brand new “transferability” concept was ushered in under Internal Revenue Code section 6418, which allows eligible taxpayers to elect to transfer certain energy tax credits to unrelated third parties for cash. Eligible taxpayers include all entities not eligible to treat certain tax credits as a payment of tax under section 6417. Generally, entities eligible to treat certain tax credits as a payment of tax are certain tax-exempt organizations and government entities (see our related tax alert for more details). Credits for which eligible taxpayers can make a transfer election (applicable credits) are the:
Temporary regulations – pre-filing registration process
Similar to section 6417, section 6418 allows Treasury to require information from or registration by eligible taxpayers before they can sell a credit. As outlined in our section 6417 alert, the temporary regulations implement a pre-filing registration process which in general, requires an eligible taxpayer to:
1. Complete an electronic pre-filing registration process through an IRS online portal,
2. Satisfy various registration requirements and receive a unique registration number prior to making a transfer election,
3. Obtain a registration number for each eligible credit property that will give rise to a credit and for which a transfer election will be made, and
4. Provide information including but not limited to information about the taxpayer, about the eligible credits, and about the eligible credit property.
Successfully accomplishing the above is not a confirmation of eligibility for the transfer election. Further, a taxpayer that does not obtain a registration number and report it on their tax return may not make a transfer election. An eligible taxpayer’s registration number is only for the taxable year for which it is obtained and must be renewed as applicable.
The proposed regulations answer several outstanding questions and reserve some issues for further guidance. The following is an overview of some of the key points in the proposed regulations.
The proposed regulations define the term transfer election. As part of the election, eligible taxpayers are allowed to transfer any portion of an applicable credit and are not required to make a transfer election as to the entire applicable credit. The transfer election has to be made with regards to a base or bonus component of the overall applicable credit. For example, an eligible taxpayer cannot separate the domestic content bonus credit amount from the total applicable credit and sell that separately.
Section 6418 requires any applicable credits be sold for cash. There was a concern that payments made for applicable credits well in advance of delivery could be viewed as a loan and then the applicable credits could be considered transferred in repayment of a loan and not for cash. The proposed regulations provide a time frame for making payments that will be treated as cash. This time period begins on the first day of the eligible taxpayer’s taxable year for which the applicable credit is determined and ends on the due date for completing a transfer election. An eligible taxpayer must make a transfer election by the due date (including extensions) of its tax return on which the applicable credit is determined.
An eligible taxpayer can make multiple elections to transfer an applicable credit to multiple taxpayers, but cannot make elections for a total amount of credits in excess of the applicable credit total.
Under certain circumstances the lessor of the property can elect to transfer credits to the lessee of the property. If such an election is made for an applicable credit the lessee cannot make a transfer election with regards to the applicable credit. Only the owner of the underlying property, the lessor, can make a transfer election.
A transfer election will generally be required to include:
(1) Information related to the transferee taxpayer and the eligible taxpayer;
(2) A statement that provides the necessary information and amounts to allow the transferee taxpayer to take into account the specified credit portion with respect to the eligible credit property;
(3) A statement that the parties are not related;
(4) A representation from the eligible taxpayer that it has complied with all relevant requirements to make a transfer election;
(5) A statement from the eligible taxpayer and the purchasing taxpayer acknowledging the notification of recapture requirements; and
(6) A statement or representation from the eligible taxpayer that they have provided a minimum amount of required documentation to the transferee taxpayer.
The election statement can be prepared at any time after the eligible taxpayer has sufficient information to prepare the election statement. That is, once the required information is known by the eligible taxpayer. The election cannot be prepared after the earlier of when the eligible taxpayer files its return reporting the applicable credit or the transferee taxpayer files its tax return on which it would report the eligible credit. The election statement would need to be filed by the eligible taxpayer and the transferee taxpayer with their tax returns. The election statement must be included on an originally filed or superseded tax return, and cannot be made on an amended tax return.
Amount of credit and ability to claim the credit
Under the proposed regulations, rules that impact the ability of a taxpayer to claim a particular credit against its tax liability do not limit the amount of an applicable credit. For example, the amount of an applicable credit that an eligible taxpayer can elect to transfer is not dependent on the passive activity loss rules under section 469. Whether the eligible taxpayer could use the credit itself is not a factor in determining the amount of the applicable credit. Rules that impact the calculation of the amount of the applicable credit do apply to the eligible taxpayer. For example, an eligible taxpayer must apply the at-risk rules under section 49 in determining the amount of the applicable credit.
The proposed regulations allow a transferee taxpayer to use any purchased applicable credits in calculating its estimated tax due. If the transferee taxpayer uses an applicable credit in its estimated tax calculation and does not purchase the applicable credit, the transferee taxpayer is liable for any penalties and interest from underpayment of estimated taxes.
The income an eligible taxpayer receives from the sale of an applicable credit is tax-free, to be classified as investment income. As it is therefore not arising from a trade or business, it will not qualify as passive income under the passive activity loss rules, accordingly.
Impact of passive activity rules. If the transferee taxpayer is subject to the passive activity rules, the credit is treated as passive. Generally, the passive activity rules apply to individuals, estates and trusts, personal service corporations, and closely held C corporations. Since the transferee taxpayer does not own the underlying property on which the credit is calculated, the transferee taxpayer cannot materially participate in the activity and cannot make a section 469 grouping election with regards to the applicable credit. In other words, a transferee taxpayer can only utilize a purchased credit in a tax year they have a tax liability stemming from other sources of passive income.
Under the proposed regulations a transferee taxpayer may apply the new carry forward and carryback rules for credits under the IRA. Under the rules a transferee taxpayer may carryback an applicable credit three years and carry forward the credit 20 years.
Comments submitted to the Internal Revenue Service requested clarification on whether the eligible taxpayer or the transferee taxpayer is subject to recapture if there is a recapture of some or all of an applicable credit. The proposed regulations cover situations where the eligible taxpayer will be subject to recapture of the credits and situations when the transferee taxpayer will be subject to recapture. If a partnership is the eligible taxpayer, a possible recapture event occurs when a partner sells some or all of its partnership interest. Similar rules apply to S corporation shareholders. Another possible recapture event is the change in a partner or S corporation shareholder’s at-risk basis under section 49. The proposed regulations treat these as partner or shareholder recapture events and the partner or S corporation shareholder would be subject to recapture.
There are also recapture events related to the property. For example, the credit property could fail to continue to qualify as credit property. The proposed regulations allocate recapture to these types of events to the transferee taxpayer.
Allocations by partnerships and S corporations
If a partnership owns the credit generating property it is the partnership that must make a transfer election. The proposed regulations allow a partnership to make a transfer election for a portion or all of an applicable credit. The proposed regulations also allow the partnership to specially allocate the tax-exempt income from the sale of an applicable credit and the portion of the applicable credit not sold, if any. For example, if some partners want to sell an applicable credit and some partners would like to be allocated the applicable credit for use on their tax return this can be done. A partnership will determine the amount of an applicable credit that would be allocated to all of the partners if the partnership did not sell the applicable credit. The partnership will specially allocate the applicable credit not subject to a transfer election to the partners. Each partner’s share of the remaining applicable credit for which it did not receive an allocation is the amount of tax-exempt income that will be allocated to that partner.
The proposed regulations do not allow this special allocation of tax-exempt income and credits for an S corporation. An S corporation may sell a portion or all of an applicable credit. However, any tax-exempt income earned by the S corporation must be allocated pro rata to the S corporation shareholders.
Section 6418 does not allow a transferee taxpayer to make a second transfer election for the same credits. The proposed regulations clarify that a partnership allocating a purchased credit to its partners or an S corporation allocating a purchased credit to its shareholders is not a second transfer.
The proposed regulations allow a partnership or S corporation to purchase applicable credits from an unrelated taxpayer and allocate the applicable credits to its partners or shareholders. This allocation of purchased applicable credits by the partnership or S corporation will not violate the restriction against a second transfer of the applicable credits.
The regulations will apply to taxable years ending on or after the date the final regulations are published in the Federal Register. Taxpayers may rely on the proposed regulations for taxable years beginning after June 21, 2023, and before the date the final regulations are published in the Federal Register. Taxpayers relying on the proposed regulations must rely on them in their entirety.
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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.