New opportunities in alternative energy investments
The Inflation Reduction Act of 2022 (IRA) extended or created numerous tax credits primarily aimed at alternative energy investments. The IRA also created the ability to transfer all or a portion of the credits to another unrelated taxpayer. The IRS issued proposed regulations pertaining to the tax credits in mid-November 2023, marking the first wholesale rewrite of the Investment Tax Credit (ITC) in 42 years! This article will explore some of the nuances of transfers.
Which credits?
There are 11 tax credits that are available for direct sale for cash, including but not limited to solar-energy ITCs as well as Production Tax Credits (PTCs) more often found with wind-energy projects.
ITC is credited one time up front based on a percentage of qualifying asset cost. In general, the credit is about 30% but can be as high as 50% based on specific qualifications such as domestic content, project location and labor requirements.
PTCs are created as energy is generated over a 10-year period and vary based on the amount of energy produced. As such, the amount of the credit is not known until the energy is produced.
Note that the tax credit for Qualified Plug-In Electric Vehicles is NOT one of the credits that can be sold, so to claim this credit, the taxpayer must also own the vehicle.
Benefits
A tax credit has a value equivalent to cash. The ability to realize the full credit or the timing of realization may incent a taxpayer to sell a credit. As of June 2023, the market for most credits was estimated at between 90-93 cents per dollar of credit, with expectations that the price may rise to 95-96 cents. Where else can one make an investment with a guaranteed immediate after-tax profit of at least 4%? If one annualized this on even a monthly basis, the after-tax return would be 48%!
Additionally, the credits may be transferred up to the due date for the annual return for the year, including extensions, so such rules provide for time to assess the risk of non-utilization before having to transfer the credits. But as with any investment, there are some risks.
Why buy or sell?
Although tax credits provide significant incentives, full utilization has sometimes been challenging for many market participants because their tax bill is currently insufficient to efficiently utilize the credits. Transferability enables the alternative energy markets to operate more efficiently by removing some of the impediments previously found. What good is a tax credit if one cannot use it? For example, U.S. subsidiaries of foreign entities may be subject to the Base Erosion Anti-Abuse Tax (BEAT) which in 2025 eliminates many tax credits 100%! Thus, an entity potentially subject to BEAT may be reluctant to invest in alternative energy projects because the substantial tax credits (at least 30% of project cost) can be totally lost!
Further complicating this issue is the fact that many of the projects that become eligible for tax credits require long lead times; being able to forecast a future tax situation is very challenging given the numerous changes that an entity may experience over time.
How it works
The credit transfer program works as follows:
- The project owner/seller registers the transaction on an IRS electronic portal and makes an election on its tax return.
- The transfer must be to another unrelated taxpayer who agrees to purchase the credits for cash; any partial cash purchase will negate the transaction.
- Tax credits can only be used to reduce 75% of a buyer’s income taxes. All or a portion of the tax credits may be transferred. In theory tax credits from a single project may thus be sold to numerous buyers.
- The transferor and transferee jointly file notice of the transfer with the IRS.
- The buyer is prohibited from transferring the ITC to any other taxpayer (i.e., no second transfers).
- If the tax credit is later disallowed, the IRS will collect 120% of the credit as a penalty from the buyer subject to the due diligence performed.
- If the ITC later becomes subject to recapture the buyer is liable for the recapture.
- ITC vests ratably over five years; any disposition by the project owner triggers recapture affecting the buyer.
Conclusion
The transferability of tax credits may open new opportunities for some leasing entities that previously were cautious about whether the substantial tax credits could be efficiently absorbed by an investor.
This may enable prospective investors to proceed with alternative energy investments knowing that if their tax situation changes, they can mitigate some of the downside by selling the tax credits.
It is questionable, however, which group within a taxpayer would be responsible for the purchase or sale of the tax credits; would it be the origination group or the tax department? So, while the benefit seems potentially robust, organizations must ascertain whose role or mission it is to help manage their tax liability.
Lastly, any potential buyers/sellers should utilize the “experts” to make sure the transactions are following the full scope of requirements in the IRA.
