Historically, energy projects have often produced more tax credits than sponsors have the ability to use. This has required sponsors to undergo a significant effort to syndicate the credits, which generally means finding investors with the right tax appetite that will invest in a project in exchange for a financial return that includes tax benefits. Syndication also often requires complex maneuvering to allocate tax credits as intended, while allowing sponsors to retain current and future rights to the projects. Additionally, agreements for tax credit syndication have to meet stringent rules in the Internal Revenue Code and from other related guidance for allocations and economic performance. These issues and complexities increased the risk of credit syndication and drove down the value of credits to third parties due to transaction costs — ultimately reducing capital available to sponsors to complete their energy projects.
As part of the revamped energy tax credit program under the Inflation Reduction Act of 2022 (IRA) for tax years beginning after December 31, 2022, sponsors and other owners now have two new potential avenues for monetizing tax credits generated by their projects: direct pay and transferability. While each of these options have their own stipulations, they are extremely valuable tools for sponsors looking to monetize tax credits. In addition, the rules should allow investors to acquire tax credits using simpler transaction structures, thus potentially creating a wider market of investors looking to acquire tax credits.
As a credit against income tax, energy tax credits have a history of only providing value to potential investors with an income tax liability. As a result, tax-exempt organizations, specifically, lack the ability to benefit from standard energy tax credits. Section 6417 of the IRA provides a new mechanism for these types of investors to benefit from credits in the form of an elective payment option, or direct pay.
Only applicable entities qualify for the direct pay option on applicable credits. Applicable credits include those under the following sections of the Internal Revenue Code:
| IRC Section | Description |
|---|---|
| 30C | Alternative Fuel Vehicle Refueling Property Credit |
| 45 | Production Tax Credit |
| 45Q | Credit for Carbon Oxide Sequestration |
| 45U | Zero-Emission Nuclear Power Production Credit |
| 45V | Credit for Production of Clean Hydrogen |
| 45W | Credit for Qualified Commercial Clean Vehicles |
| 45X | Advanced Manufacturing Production Credit |
| 45Y | Clean Electricity Production Credit |
| 45Z | Clean Fuel Production Credit |
| 48 | Investment Tax Credit |
| 48C | Qualifying Advanced Energy Project Credit |
| 48E | Clean Electricity Investment Credit |
Applicable entities generally include any organization exempt from income tax, as well as select state and governmental authorities. Exceptions exist for credits under Sections 45V, 45Q and 45X, which allow any taxpayer to be considered an applicable entity for purposes of direct pay of those credits, subject to certain restrictions.
To qualify for direct pay:
Special rules apply to any partnership or S corporation making this election around the allocation and distribution of these credits. Additionally, excessive payment rules exist, which may penalize applicable entities who applied for and received direct payment of a credit in excess of the allowable amount.
While only certain types of entities qualify for the direct pay election under Section 6417, those that do not are provided with an alternative monetization method under Section 6418. This Section offers an option to elect a one-time transfer of tax credits between taxpayers. Transfers of tax credits are eligible to be made in connection with payments received, effectively allowing for a direct sale of their tax benefit.
Like Section 6417, only applicable entities may elect transfer treatment on eligible credits. Applicable entities for Section 6418 purposes, however, include any taxpayer that is not considered an eligible entity for Section 6417 — or, in other words, taxpayers subject to income taxes. Eligible credits include all the same credits eligible for Section 6417, with the exception of credits under Section 45W, which are not available for transfer.
To transfer IRA energy tax credits between taxpayers:
Like the excessive payment restrictions under the direct pay rules, excessive credit transfers are similarly calculated and penalized.
As the IRA is an important initiative for the IRS and Treasury, guidance addressing the application of Sections 6417 and 6418 is currently in progress. However, at least for now, we are left with many unanswered questions.
Specifically, taxpayers will need more detail on the format for making elections, clarity on how these rules will apply to partnerships and S corporations that make elections, and information on how to determine excessive payment and excessive credit transfers. Additionally, advocates have called for exceptions to the penalty applications of excessive payments and credit transfers based on the facts and circumstances of each case.
The streamlined options available in the IRA will reduce or eliminate tax credit syndication requirements of the past and make applicable credits more valuable to all parties involved. While these options simplify the process, sponsors and investors must both understand, and should likely consider and plan for, these credit monetization options, including structuring options to optimize effectiveness.
Contact Justin Gartner at jgartner@cohencpa.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.