The Federal government's unprecedented move in the Inflation Reduction Act of 2022 (IRA) allows certain eligible investment and production tax credits to be sold from the party that generates the tax credit to an unrelated party solely for cash. The frenzy to market and sell these credits has begun. Despite the appeal to support various green energy initiatives, individual and other certain buyers need to be cautious and understand the details of their tax situation when considering acquiring such credits.
Treasury and the Internal Revenue Service (IRS) released proposed Treasury regulations that provide detailed guidance on transferring these credits including significant limitations on how these credits will be treated for a certain group of taxpayers that are subject to passive loss rules (i.e., individuals, estate, trusts, closely held C corporations, and personal service corporations).
Specifically, these credits are automatically treated as credits from passive activities, meaning taxpayers must have sufficient net income from passive activities to use these credits to offset the resulting tax liability on that passive net income. Importantly for purposes of determining the amount of passive income, gross income from interest, dividends, annuities, royalties as well as gain or loss from the sale of such property is not considered passive income so tax liability on this portfolio income cannot be offset with these credits.
Automatically treating these credits as passive eliminates most individuals from being able to effectively use the credits to offset tax. Nonetheless, these credits may still be marketed to individuals as a way to reduce income tax. Given the passive nature of these credits and the risks associated with purchasing them (see below), buyers should beware.
Credit Buyers Bear Significant Risks
The buyers of such credits bear the risk of IRS scrutiny of the credit itself under audit. The credit buyer should ensure that the seller provides all required documentation to validate the existence of the energy property or energy facility, support for any bonus credit amounts included in the credit purchased and evidence of qualifying costs or production associated with the credit for the taxpayer’s records to support the credit. Additionally, certain of these credits can be recaptured upon specific events that happen at the energy facility or to the energy property independently of the credit buyer, but the buyer still bears the tax burden associated with certain recapture events.
General Transferability Overview
The IRA allows for transferring eleven eligible credits:
- Alternative fuel vehicle refueling property credits (section 30C);
- Renewable electricity production credits (production tax credits/PTCs) (section 45(a));
- Carbon oxide sequestration credits (section 45Q(a));
- Zero-emission nuclear power production credits (section 45U(a));
- Clean hydrogen production credits (section 45V(a));
- Advanced manufacturing production credits (section 45X(a));
- Clean electricity production credits (section 45Y(a));
- Clean fuel production credits (section 45Z(a));
- Energy credits (investment tax credits/ITCs) (section 48);
- Qualifying advanced energy project credits (section 48C); and
- Clean electricity investment credits (section 48E).
The proposed regulations on transferability provide guidance for elections to transfer eligible credits, special rules for partnerships and S corporations, pre-filing requirements with the IRS, and rules regarding excessive credit transfers and associated penalties, basis reduction, recapture and carryforward and carryback. The following are additional highlights of the proposed regulations:
- Prohibit an eligible taxpayer from separately transferring the base credit amount without the bonus credit amounts. An eligible taxpayer may, however, transfer all of an eligible credit or a portion thereof, provided a proportionate share of the base credit amount and all bonus credit amounts are included.
- Clarify what is considered paid in cash, the timing on making such cash payment, safe harbor timing rule as to when a payment does not violate the paid in cash requirement and whether advance contractual purchase commitments violate the paid in cash rule. If any amount other than cash is received, the transfer election is completely disallowed.
- Confirm that once made, the transfer election is irrevocable.
- Permit an eligible taxpayer to make multiple transfer elections transferring eligible credits to more than one transferee so long as no more than the total eligible credit is transferred.
- Require the transfer election to be made on an original return (with no Section 9100 late election relief).
- Establish rules about the mandatory registration process, including eligible taxpayers registering before filing the return on which the transfer election is to be made, and pre-filing registration requirements.
- Establish rules about excessive credit transfers and associated penalties.
- Clarify that the transferee bears the burden of recapture and that the recapture amount is taken into account by the transferee.
All that is marketed as green may not be so green in certain taxpayers' hands and may come with significant risks. Weaver is here to help navigate the green frenzy of buying credits. Contact us for more information.