On April 25, 2024, the U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued final regulations (the Final Regulations) regarding the election to transfer energy tax credits under Section 6418 of the Internal Revenue Code of 1986, as amended (the Code), pursuant to changes authorized by the Inflation Reduction Act of 2022 (IRA). The Final Regulations update the initial proposed regulations issued on June 14, 2023 (the Proposed Regulations), discussed by Wilson Sonsini, relating to the transfer of eligible credits.

The IRA and Credit Transferability Primer

The IRA created the “transferability” regime to monetize energy tax credits. The Final Regulations apply to the following tax credits, categorized by technology:

• Renewable Energy Generation: Code Sections 45 and 45Y (production tax credit (PTC) and technology-neutral PTC); Code Sections 48 and 48E (investment tax credit (ITC) and technology-neutral ITC); Code Section 45U (nuclear production tax credit)
• Carbon Capture and Sequestration: Code Section 45Q (carbon capture, use, and sequestration tax credit)
• Clean Fuels: Code Section 45V (hydrogen production tax credit); Code Section 45Z (clean fuels production tax credit)
• Manufacturing: Code Section 45X (advanced manufacturing production tax credit); Code Section 48C (advanced energy project tax credit)
• Vehicles: Code Section 30C (alternative fuel vehicle refueling property tax credit)

Transferability means that tax credits can be bought and sold. The tax credits noted above can be “transferred” (i.e., sold or assigned) once and may not be sold again by the buyer who acquires them. Notably, a facility or project owner can transfer tax credits but cannot transfer depreciation benefits in a transferability transaction. Depreciation benefits are typically coupled with the tax credits for a particular project—a tax credit reduces, dollar-for-dollar, taxes owed, whereas depreciation is a deduction, meaning it reduces a taxpayer’s overall taxable income to which tax credits are applicable. Taxpayers who claim the ITC, for example, can generally claim depreciation deductions as an expense on an accelerated schedule, which allows the taxpayer to reduce taxable income. Depreciation benefits can be significant in tax equity financings, particularly for utility-scale solar, which may make tax credit sales for certain utility-scale projects less attractive overall.

Transferability is intended to facilitate financing renewable energy projects by opening up a market to new types of investors outside of traditional institutional tax-equity players. Overall, the cost-benefit equation between traditional tax equity structures and new tax credit sales, or hybrid structures that combine both elements of a traditional tax equity transaction together with transferability, will come down to various factors—such as the ability to realize depreciation and step-up benefits and general transaction costs—that may make traditional tax equity vehicles less efficient because of their associated legal structuring costs and tax considerations.

Key Takeaways

The Final Regulations:

• clarify how taxpayers may correct transfer election credit amounts claimed in error on an original tax return and also seek administrative relief;
• provide further guidance on the anti-abuse provisions with respect to transfer elections, using an arm’s length standard, as opposed to more specific price data;
• illustrate the credit recapture rules with respect to partnerships and S corporation shareholders; and
• retain the rule in the Proposed Regulations prohibiting “horizonal” slicing of credits (i.e., transferring bonus credits separate from the base credit), but still allow “vertical” slicing of credits (i.e., transferring only part of the eligible credit amount and retaining the remainder of the eligible credit amount).

Definition of Eligible Credit for Purposes of Section 45Q

Final Regulation § 1.6418-1(d)(3) provides that the definition of eligible credit property for purposes of Section 45Q credits is a component of a single process train for the capture, disposal, utilization, or injection of qualified carbon oxide, rather than a single process train of carbon capture equipment. In effect, the Final Regulation does not require a taxpayer to own every component of a single process train with respect to carbon capture property under Section 45Q.

Rules for Making Transfer Elections

Revisions for Grantor Trust Ownership Arrangements. Final Regulation § 1.6418-2(a)(3)(v) provides that if an eligible taxpayer is a grantor or any other person that is treated as the owner of any portion of a trust under Section 671, then the eligible taxpayer may make a transfer election under Final Regulation § 1.6418-2 for any eligible credits determined with respect to eligible credit property held by such trust.

Manner of Making a Valid Transfer Election. The Final Regulations clarify that the registration number received during the mandatory pre-filing registration under Proposed Regulation § 1.6418-4 must be included on a properly completed IRS Form 3800 and any relevant credit source form with respect to the eligible credit property.

Original Return Requirements and Corrections for Credit Transfers. Final Regulation § 1.6418-2(b)(4) provides that a transfer election filed by an electing taxpayer must be made on an original return for the taxable year for which the eligible credit is determined. No transfer election may be made for the first time on an amended return, withdrawn on an amended return, or made or withdrawn by filing an administrative adjustment request (AAR) under Section 6227. However, a numerical error with respect to a properly claimed credit transfer election may be corrected on an amended return or by filing an AAR. If such a correction is required, an eligible taxpayer’s original return must contain all the information reporting requirements under Section 6418, including the pre-filing registration number of the relevant credit source form. Corrections on original returns must relate to substantive items; blank items or items described as “available upon request” may not be corrected under the Final Regulations.

Late Election Relief. Final Regulation § 1.6418-2(b)(4)(i) provides that eligible taxpayers may seek relief under Treasury Regulation § 301.9100-2(b) if the eligible taxpayer has not received an extension of time to file a return after the original due date, has timely filed a return, takes corrective action under Treasury Regulation § 301.9100-2(b) within the six-month extension period, and meets the procedural requirements under Treasury Regulation § 301.9100-2(d).

Amendments to Eligible Credits—Credit Increases. Final Regulation § 1.6418-2(b)(4)(ii) clarifies that if an eligible electing taxpayer determines that the reported eligible credit amount on the taxpayer’s original return is incorrect, then the taxpayer may timely file an amended return or AAR to adjust the credit amount. Final Regulation § 1.6418-2(b)(4)(ii)(B) further provides that where an amendment increases the amount of the eligible credit reported, the increased amount may not be transferred.

Amendments to Eligible Credits—Credit Decreases. Final Regulation § 1.6418-2(b)(4)(ii)(C) clarifies that if an amendment to an eligible taxpayer’s eligible credit amount decreases the eligible credit, then the decreased amount i) reduces the eligible credit not transferred by the eligible taxpayer, and ii) the remaining decreased credit balance amount reduces the amount of each transferee’s credit portion pro rata.

Treatment of Cash Consideration. Final Regulation § 1.6418-2(b)(4)(ii)(D) provides that, in the event of a credit decrease, any cash consideration retained by the eligible taxpayer is not treated as tax-exempt income. Final Regulation § 1.6418-1(f)(3) states that contracts to purchase credits in advance of a credit portion transfer must be paid in cash beginning on the first day of the eligible taxpayer’s taxable year during which a specified credit portion is determined and ending on the due date for completing a transfer election.

Treatment of Payments Made in Connection with a Transfer Election

Final Regulation § 1.6418-2(e)(4)(i) provides that a transfer election of any specified credit portion may be disallowed or recharacterized when the principal purpose of the transaction is to avoid federal income tax liability beyond the intent of Section 6418. To that end, the examples to Final Regulations §§ 1.6418-2(e)(4)(ii) and (iii) state that for purposes of the anti-abuse rules, the transfer price will be examined in reference to an arm’s length price of eligible credits without regard to other commercial relationships in order to determine whether such a transaction was effected to allow an eligible taxpayer to avoid gross income. The Final Regulations replace Proposed Regulations §§ 1.6418-2(e)(4)(ii) and (iii), which previously referred to “the average transfer price of the eligible credit between unrelated parties” in determining whether such transactions are subject to the anti-abuse provision under Section 6418(h). With this change, the Final Regulations avoid issues of classifying average price data in a given transaction that may depend on the particular facts and circumstances of a given transfer election agreement.

Transferee Taxpayer’s Treatment of Eligible Credits

Clarification of Taxable Year for Transferees. Final Regulation § 1.6418-2(f)(1) provides that for purposes of determining the taxable year in which a credit is taken into account under Section 6418(d), a 52-53 week taxable year of an eligible taxpayer or transferee is deemed to end on or close on the last day of the calendar month nearest to the last day of such taxable year.

Material Participation and Grouping Rules. The Final Regulations confirm that transferred credits are treated as derived in connection with a trade or business, and thus are subject to the passive loss rules in Section 469. Final Regulation § 1.6418-2(f)(3)(ii) clarifies that, for purposes of Section 469, a transferee taxpayer will only be treated as owning an interest in an eligible taxpayer’s trade or business if the transferee owns such an interest at the time the work was done, and the credit transfer will not change the determination of the transferee’s material participation in that respect. Accordingly, a transferee taxpayer’s participation (or lack thereof) in the eligible taxpayer’s trade or business under the grouping rules in Treasury Regulation § 1.469-4(c) is not affected by the eligible taxpayer’s participation in the trade or business under these rules.

Estimated Tax Payments. The preamble to the Final Regulations provides that transferees may take into account credits they intend to purchase for purposes of estimated tax payments but does not elaborate further on the specific mechanics for taking into account transferred credits for purposes of estimated tax payments.

Partnerships and S Corporations

Upper-Tier Partnerships. The Final Regulations clarify rules applicable to an upper-tier partnership that is a direct or indirect partner in a transferee partnership. Specifically, an upper-tier partnership’s distributive share of a transferred specified credit portion is treated as an extraordinary item to the upper-tier partnership, necessitating such credit portion to be allocated among the partners of an upper-tier partnership at the time of the transfer in accordance with Final Regulation § 1.6418-3(b)(3)(iv) and Treasury Regulations §§ 1.706-4(e)(1) and (e)(2)(ix).

Extensions and Election Relief. Final Regulation § 1.6418-2(b)(4) permits an automatic six-month extension of time under Treasury Regulation § 301.9100-2(b) to make a transfer election as described under Section 6418(e)(1). In addition, Final Regulation § 1.6418-3(d)(2) provides late-election relief under Treasury Regulation § 301.9100-2(b) for partnerships or S corporations that make a transfer election and subsequently correct a numerical error with respect to a properly claimed transfer election credit on an amended return or AAR. The partnership or S corporation’s original return must have been signed under penalties of perjury and must have contained all of the information, including a registration number, as required by the Final Regulations.

Special Rules

Payments Related to Excessive Credit Transfers. Final Regulation § 1.6418-2(a)(1) provides that, in general, if any specified credit portion transferred to a transferee taxpayer is determined to be an excessive credit transfer (as defined in Final Regulation § 1.6418-2(d)(5)), the tax imposed on the transferee will be increased by i) the amount of the excessive credit transfer and ii) 20-percent of the excessive credit transfer. Further, Final Regulation § 1.6418-5(a)(3) provides that any consideration paid by a transferee taxpayer to an eligible taxpayer that directly relates to an excessive credit transfer is no longer part of the tax-exempt consideration, making it taxable to the transferor and a deductible expense to the transferee. This amount will be equal to the total consideration paid in cash by the transferee multiplied by the ratio of the excessive credit amount transferred to the transferee to the amount of the credit portion claimed by the transferee.

Recapture Events under Section 50(a). Final Regulation § 1.6418-5(a)(5) provides that a recapture event under Section 45Q(f)(4), 49(b), or 50(a) is not an excessive credit transfer. Final Regulation § 1.6418-5(d)(3)(i) further states that the transferee taxpayer is responsible for any amount of tax increase under Section 50(a) for recapture events in proportion to the amount of the eligible credit transferred to the transferee taxpayer over the total eligible credit amount. Similarly, the amount of the tax increase under Section 50(a) determined with respect to the transferor is equal to the recapture amount in proportion to the retained credit amount over the total eligible credit amount.

Final Regulation § 1.6418-5(d)(3)(iii) provides rules for recapture events with respect to transferor partners or S corporation shareholders. In effect, if a partner or shareholder is subject to recapture individually and the project is later subject to recapture, then the recapture liability determination will take into account the amount previously recaptured by the individual partner or shareholder.

Recapture Example—Partnerships. The recapture rules with respect to partners are illustrated in Final Regulation § 1.6418-5(d)(3)(iv) Example (1)(A) and (B), which provides a situation where four equal partners (A, B, C, and D) agree to share all items of income, gain, loss, deduction, and credit within the partnership, filing on a calendar year basis. The partnership subsequently invests $1,000x in an energy property under Section 48 and places the property into service. At the end of the tax year, the partnership has $300x of eligible Section 48 credits. In this case, the distributive shares of the credit under the partnership agreement are determined under Treasury Regulations §§ 1.46-3(f) and 1.704-1(b)(4)(ii), equal to $75x (based on each partner being allocated basis of $250x). All partners agree that of A’s $75x share, $60x of eligible credits will be transferred and $15x of the eligible credits will be allocated to A. The partnership transfers the $60x of its Section 48 credits to an unrelated third party, Y. On the first day of the next taxable year, A sells 50 percent of its interest in the partnership, resulting in a recapture event under Treasury Regulation § 1.47-6(a)(2). A is subject to recapture caused by the disposition of its interest, and A calculates recapture based on half of its share of the basis of the credit property ($125x), because A disposed of 50 percent of its partnership interest. The recapture amount, or tax increase that A is responsible for, is $37.5x, calculated by A’s retained credits and A’s distributive share of the transferred Section 48 credits. The recapture event reduces the total potential recapture of the investment credit property from $300x to $262.5x. Y is not subject to recapture due to A’s disposition, however, if a recapture event occurs later with respect to the energy property, A’s disposition and recapture amount will be taken into account in determining Y’s recapture amount.

Credit Carryforwards. Final Regulation § 1.6418-5(h) clarifies that transferees may carry forward (in addition to carrying back) unused credit amounts under Section 39(a)(4).

Real Estate Investment Trusts (REITs). Final Regulation § 1.6418-5(i)(1) provides that if a REIT has eligible credits that it may transfer, the value of those credits is not included in determining the value of the REIT’s total assets under Section 856(c)(4). Final Regulation § 1.6418-5(i)(2) further states that the transfer of a specified credit portion under a valid transfer election is not a sale under Sections 857(b)(6)(C)(iii) and 857(b)(6)(D)(iv).

The Final Regulations will be effective as of June 29, 2024.