Treasury, IRS Release Final Regulations on Transfer of Certain Energy Tax Credits

The Department of the Treasury and the IRS on April 25 released long-awaited final regulations (T.D. 9993) related to the transfer of certain credits under Internal Revenue Code Section 6418, added by the Inflation Reduction Act (IRA), which describes rules for the election to transfer eligible credits in a taxable year. 

Effective July 1, 2024, the final regulations adopt the proposed and temporary regulations (REG-101610-23) issued on June 21, 2023, with some modifications that include definitions and clarifications of special entity rules, excessive credit transfer elections, and recapture events. The IRS also updated the frequently asked questions based on the final regulations. 

For prior coverage, see Transferable Energy Credits May Require Registration Soon.

While eligible taxpayers have successfully transferred certain credits under the temporary regulations, the final regulations provide further guidance in response to taxpayer concerns and requests for clarifications.

The final regulations come after Treasury and the IRS on March 5 finalized elective payment rules under IRC Section 6417. For prior coverage, see Treasury, IRS Release Final Regulations on Elective Pay Election for Energy Tax Credits. 

Because facilitating the transferability of certain eligible credits is expected to be a substantial task for the IRS, the final regulations place a strong emphasis on the administration of IRC Section 6418 to ensure proper mitigation of the potential risk of fraud and abuse. 

For related coverage of the tax accounting rules governing the treatment of amounts paid or received for income tax credits, see Sales of IRA Tax Credits Entail Special Tax Accounting Considerations.

Background

The IRA introduced, for tax years beginning after December 31, 2022, the ability for eligible taxpayers to transfer all or a portion of eligible credits to unrelated taxpayers for cash under IRC Section 6418. The unrelated taxpayers can then claim the transferred credits on their tax returns. 

Guidance on Eligible Credits

The final regulations further define the meaning of eligible credit property based on the underlying rules for the eligible credit, with a few points of technical clarification. Regarding the transfer of eligible credits, the final rules confirm that horizontal transfers of bonus credits – that is, transferring bonus credits separate from the underlying eligible credit -- are not permitted. Conversely, vertical credit transfers -- transferring the entire credit or a portion of the entire eligible credit with a proportionate amount of bonus credit -- are permitted.  Further, the government elaborated that the bonus credit itself is not an eligible credit, but rather an amount taken into consideration with respect to eligible credit property depending on the underlying credit rules. 

Allowing horizontal credit transfers would add an additional layer of complexity for the IRS to administer, as the base and bonus credits amounts would need to be separately monitored for each energy property. Additionally, Treasury and the IRS reiterated that progress expenditures cannot be transferred in response to suggestions of transferring Section 48 investment tax credit portions prior to the year in which the energy property is placed in service. 

Treatment of Payments

The paid-in-cash requirements remain unchanged from the proposed rules. While stakeholders suggested permitting advanced payments before the taxable year in which an eligible credit is determined to better align with historic tax equity structures, especially as it relates to production tax credits, the government chose not to modify the paid-in-cash definition because of concerns about the complex legal and administrative challenges that could emerge. These challenges include tracking the occurrence of excessive credit transfers and potential impact on gross income if prepaid eligible credits are not ultimately transferred.  However, the final regulations do acknowledge that third-party loans secured by an eligible credit purchase and sale agreement may be possible, but refrained from specifically opining on those arrangements, stating that they fall outside the scope of the final regulations. 

Making a Transfer Election

The final regulations largely adopt the proposed rules regarding the contents of a valid transfer election without change, except to clarify that the pre-filing registration number must be included on a properly completed relevant credit source form. 

According to Section 6418(e)(1), the transfer election must be filed on an originally filed return by the extended due date. Eligible taxpayers may correct errors or omissions on a superseding return up until the extended due date. While the final regulations do not define a superseding return, administrative IRS guidance provides that a superseding return is a return that is filed after the originally filed return, but before the due date for filing said return (including extension). 

A transfer election may not be made on an amended return or by filing an administrative adjustment request (AAR). However, the final regulations allow for the correction of numerical errors in a properly filed transfer election, such as miscalculated eligible credit amounts or typographical errors, either on an amended return or by filing an AAR. Corrections must pertain to information that was initially provided; they cannot be used to fill in missing information or address fields left as “available upon request.” This guidance is crucial for correcting typographical or calculation errors to prevent the transfer of excessive credits.

While partnerships and S corporations – rather than partners or shareholders – may elect to transfer an eligible credit, it was unclear who is responsible for registering an eligible credit and electing to transfer when the energy credit property is owned by a grantor trust. The final regulations add Reg. §1.6418-2(a)(3)(v) to specify that if a grantor or any other individual is recognized as the owner of a trust under Section 671, then they are eligible to make a transfer election for eligible credits with respect to eligible credit property held directly by the portion of the trust that the eligible taxpayer is deemed to own under Section 671. 

During the comment period, stakeholders suggested allowing transfer elections after a lease passthrough election to avoid the need for more complex sale-leaseback arrangements solely for the purpose of transferring credits. The IRS declined to modify the proposed rules, and the final rules clarify that the owner or lessor is the transferee taxpayer; the lessee cannot claim the credit nor meet the requirements under Section 6418(a) to make a transfer election.

Treatment of Transferee Taxpayers

The final regulations address several topics relevant to transferee taxpayers. For example, with regards to excessive transfers, while the final rules do not adopt an explicit ordering rule in cases where a portion of a specified credit is transferred, the government commented that there is effectively an ordering rule embedded within the definition of excessive transfers. In cases where there is a disallowed credit, the disallowed credit would apply against the eligible taxpayer first, so that the excessive transfer would apply only to the extent the disallowed credit exceeds the amount retained by the eligible taxpayer. 

Additionally, the final rules offer some guidance on the tax implications to transferee taxpayers. Treasury and the IRS updated the proposed regulations to clarify that payments related to an excessive credit transfer by the transferee are not subject to the rule under Section 6418(b)(3), which generally precludes the deductibility of payments by the transferee taxpayer. The final regulations further provide how to determine the deductible portion of the payment. However, the timing and character of any deductions, the effects on gross income for an eligible taxpayer, and the consequences of insurance or indemnity payments are left to be governed by general income tax principles, as these issues are not addressed in the final regulations. 

Under Section 6418(d), the transferee taxpayer takes the eligible credit into account in the first taxable year of the transferee taxpayer ending with, or after, the tax year of the eligible taxpayer with respect to which the credit was determined. The preamble to the proposed regulations provided that as part of taking into account the eligible credit, transferee taxpayers may consider the eligible credit when calculating their estimated tax payments.  Treasury and the IRS declined to add specific rules on calculating estimated tax payments as it is largely a facts-and-circumstances exercise in determining the appropriate treatment.  However, the final rules do clarify that the transferee taxpayer cannot consider the eligible credit for its quarterly estimated tax payments earlier than an eligible taxpayer would. 

With regards to the transferee taxpayer’s tax payments, stakeholders had requested clarification of the phrase “intends to purchase” that was included in the preamble to the proposed regulations. The final rules reiterate that a transferee taxpayer that plans to but has not yet completed a transaction that meets the requirements under Reg. §1.6418-2(b) may nonetheless consider the eligible credits for purposes of estimated tax. However, in all cases where the amount of credit ultimately transferred is less than or not obtained as expected, the transferee taxpayer remains liable for additional tax in accordance with Sections 6654 and 6655. 

Pre-Filing Registration

As stated in Section 6418(g)(1), the IRS may require information or registration as necessary to prevent duplication, fraud, improper payments, or excessive payments due to credit transfers. In late 2023, the IRS released its pre-filing registration tool to help track the transfer of eligible credits. 

While stakeholders generally acknowledge the need for pre-filing registration of eligible credits, several comments were received related to its implementation. Stakeholders requested more timely responses with respect to registration numbers and suggested permitted credit transfers without registration completion, provided the pre-filing registration application had been submitted prior to credit transfer. 

Treasury and the IRS referred stakeholders to the existing guidance in Publication 5884 and largely declined to modify the pre-filing registration process, highlighting its importance in supporting the IRS's administrative burden overseeing credit transfers. The government stated that it will closely monitor the pre-filing registration tool and implement improvements as needed to enhance its efficiency. However, any changes to the pre-filing registration process would be made independently of the final regulations.

Commenters requested that the final rules permit grouping for registration and transfer purposes. The final regulations provide that such grouping is permissible only if the underlying rules for each eligible credit allow it; otherwise, each eligible credit property must be registered individually. 

Comments were submitted specifically regarding the grouping of charging properties under Section 30C for registration purposes, arguing that individual pre-registration would be overly burdensome and costly in some cases, and bundling multiple projects across different locations into a single pre-registration would be a way to streamline the process and reduce costs. However, Treasury and the IRS did not adopt this suggestion for Section 30C, citing concerns over subjectivity and potential discrepancies in interpretation between taxpayers and the IRS. Therefore, the ability to group eligible credit property remains tied to the specific definitions under the relevant Code section and the regulations for the underlying eligible credit. For Section 30C and certain other credits, the pre-filing registration portal does allow for bulk uploads of property information, as mentioned in Publication 5884.

Observations

The final regulations address concerns related to the passive credit rules under Section 469, a topic that generated significant discussion among stakeholders. Many argued that these rules would overly limit the pool of potential transferee taxpayers. They pointed to the New Markets Tax Credit (NMTC) under Section 45D and Rev. Rul. 2010-16, which found the passive credit rules inapplicable to Section 45D, as precedent. However, Treasury and the IRS ultimately did not accept the suggestion to exempt transferred credits from the passive credit rules. They distinguished between eligible credits and the NMTC by noting that, unlike the NMTC, eligible credits are generated through the conduct of a trade or business, whereas the NMTC is generated through investment activity in a community development entity.

Real estate investment trusts (REITs) are addressed in the final regulations. Treasury and the IRS clarified that eligible credits that have been generated but not yet transferred are not considered in the REIT asset test. Additionally, the final regulations confirm that cash received from the transfer of an eligible credit is excluded from the gross income of the eligible taxpayer, thereby not contributing to net income relevant for prohibited transaction tax concerns. Furthermore, the final regulations clarify that the transfer of eligible credits does not constitute a property sale within the context of the seven sales outlined under Sections 857(b)(6)(C)(iii) and (D)(iv).

The final regulations address ownership concerns related to the Section 45Q credit, adding that guidance under Section 45Q does not require a taxpayer to own every component of a single process train. Further, while a contractor’s activities may be essential for determining a Section 45Q credit, the final rules clarify that the credit ultimately belongs to and is determined by the individual or entity that owns the equipment and is responsible, either physically or through contractual agreements, for the capture and subsequent disposal, injection, or utilization of the qualified carbon oxide. 

The final regulations add that the Section 45X credit is the only credit for which ownership of property is not required, due to the potential of contract manufacturer arrangements. For prior coverage of Section 45X, see Treasury, IRS Release Proposed Regulations on Advanced Manufacturing Production Credit.