The tax credit sale market should ramp up quickly now that the Internal Revenue Service has issued guidance on such sales.

The guidance, issued on June 14, will require revisiting some tax credit sale transactions where documents have already been signed.

The Inflation Reduction Act allowed companies to sell tax credits to other companies for cash. Such sales became possible on January 1, 2023.

Some transactions have already closed, but not yet funded. Most sales have been in the 90¢ to 93¢ range per dollar of tax credit, but prices have been creeping up, and many people expect them to settle around 95¢ or 96¢. Prices vary by technology, the creditworthiness of the seller and the time period between when the purchase price must be paid and when the buyer can apply the tax credit to offset a tax liability to the government. The shorter the time period between cash payment and use, the more the buyer should pay.

The new guidance is in the form of proposed regulations that can be found here. The IRS will take comments through August 14.  

The proposed regulations will require buyers to do careful diligence before buying tax credits.

They make the tax credit buyer responsible if the tax credits are later disallowed or reduced by the IRS on audit. After an audit adjustment, the IRS will collect 120% of the disallowed tax credits from the buyer as a penalty. The buyer can avoid the penalty, but not the obligation to repay the disallowed tax credit amount, by doing careful diligence. Although the IRS did not say which party -- the tax credit seller or buyer -- will have to pay the interest and any other penalties on the back tax adjustment, the buyer should expect to have to pay those as well. It is the buyer's tax return that will be audited. Interest and other penalties can add significantly to the back taxes owed.

The proposed regulations also require buyers to repay the US Treasury in cases where investment tax credits and so-called section 45Q credits for capturing carbon dioxide emissions are recaptured -- for example, because a wind or solar project on which an investment credit is claimed suffers a casualty or is sold by the owner within five years after it is placed in service or where captured CO2 that has been sequestered leaks from underground within the first three years after sequestration.

Buyers will demand creditworthy indemnities if the tax credits they purchase are denied later on audit. The indemnities will have to compensate the buyer not only for the lost money it paid for the tax credits, but also for the amount it must pay the US Treasury.  

The proposed regulations do not allow a project owner to sell only a bonus tax credit on a project -- for example, for putting the project in an "energy community" or using enough domestic content -- and keep the base tax credit. However, a partnership that owns a project can sell one or more partners' shares of tax credits while allocating the remaining tax credits to the other partners.

Individuals will have a hard time being tax credit buyers.

Buyers can carry back the tax credits they buy up to three years and use them to recover taxes paid in the past.

There is a danger that the IRS will disallow the whole transaction if the buyer pays less than the full market value of the tax credits in cash.

Tax credit sellers will have to do a number of things, including registering transactions on an IRS electronic portal and providing buyers with proof that projects exist, are exempted from or have complied with wage and apprentice requirements and qualify for any bonus tax credits that are included in the sale. Failure to provide this "minimum documentation" will negate the sale.

Eleven Credits 

Eleven types of tax credits can be sold.

They are tax credits under the following US tax code sections: 45, 45Y, 48, 48E, 45Q, 45V, 45U, 45X, 45Z, 48C and 30C.

The 11 credits are tax credits for generating renewable, nuclear or other zero-emissions electricity, tax credits for capturing carbon emissions or producing clean hydrogen and clean transportation fuels (like sustainable aviation fuel), tax credits for manufacturing wind, solar and storage components or processing, refining or recycling 50 types of critical minerals, tax credits for building new factories and re-equipping existing assembly lines to make or recycle products for the green economy and reduce greenhouse gas emissions at existing factories by at least 20%, and tax credits for installing electric vehicle and other clean fuel charging stations in low-income and rural areas.

Tax credits can only be sold once. Thus, a buyer cannot resell the tax credits it purchases.

Tax credits that a project owner has assigned to another party cannot be sold.

For example, some projects are financed using inverted leases where the owner leases the project to a tax equity investor and passes through the investment tax credit on the project to the investor. (For more detail, see "Inverted Leases" here.) Another example is where a company capturing carbon dioxide emissions at an ethanol plant or factory chooses to transfer the section 45Q tax credits for carbon capture to the company that sequesters the captured CO2 underground or uses it for enhanced oil recovery or in a permitted commercial application. The inverted lessee or assignee of such tax credits cannot sell them.

Developers building projects, like offshore wind farms, that have normal construction periods of at least two years, can claim investment tax credits on progress payments made to the construction contractor during construction rather than waiting, as in the normal case, until the project is placed in service to claim the full tax credit. These so-called QPE tax credits —- QPE stands for qualified progress expenditures —- cannot be sold. Thus, an offshore wind developer planning to sell tax credits should not claim investment tax credits on construction progress payments.

The lessor in a sale-leaseback can sell the investment tax credit on a project. It is entitled to the tax credit by virtue of owning the project. (For more detail on sale-leasebacks, see "Solar Tax Equity Structures" here.)

Tax Credit Sale

The deadline to sell tax credits for a year is the due date for the annual tax return for the year, including extensions. Thus, a project owner using a calendar tax year could complete a sale of 2023 tax credits as late as September 15, 2024 if the seller is a partnership or October 15, 2024 if the seller is a corporation or individual, assuming it delays filing its 2023 tax return until then.

The buyer must pay cash.

The IRS will negate any tax credit sale where the buyer pays the purchase price only partly in cash. Thus, there is a danger in transactions where the cash paid is less than the market value that the IRS will say the seller received something other than cash and negate the sale.

The full cash purchase price must be paid between the first day of the seller's the tax credit year and the earlier of the date the seller or buyer files its annual tax return. For example, a seller using a calendar tax year and selling 2023 tax credits must be paid the full purchase price between January 1, 2023 and when the seller or buyer files its tax return reporting the tax credit sale.

The proposed regulations require buyers to pay year-by-year for production tax credits. Production tax credits are claimed over time, unlike investment tax credits that are claimed in the year a project is put in service. Developers making forward sales who want the full purchase price at inception would have to borrow bridge debt against the future revenue stream from a bank or other lender, including by structuring any payment by the tax credit buyer for future tax credits as a loan. It is unclear why the Treasury cares.

Tax credits that are carried forward or backward into a year from another year cannot be sold.

The tax credit buyer cannot be related to the seller.

It is related if it has more than 50% overlapping ownership. A buyer is related to a corporate seller if the buyer or an affiliate owns more than 50% of the stock. A buyer is related to a partnership seller if the buyer or an affiliate has more than a 50% profits or capital interest in the partnership.

A seller can transfer all or part of the tax credits. For example, the sale can be for a percentage of the tax credits. It can probably be for a set dollar amount of tax credits.   

If a partnership owns the project, the tax credits must be sold by the partnership. Individual partners cannot sell their shares directly. The buyer can also be a partnership. A buyer partnership must allocate the tax credits it purchases among the buyer partners in the same ratio that a type of loss called a "section 705(a)(2)(B) expenditure" is allocated. If the buyer partnership makes no special provision for such losses, then they are allocated in same ratio as other losses.

A buyer partnership might be used to syndicate purchased tax credits. However, the tax credits are considered "extraordinary items," meaning that new partners can only share in tax credits that arise after they enter the partnership. For example, an investment tax credit arises on the date the project is placed in service. Production tax credits arise as electricity, hydrogen or manufactured components are sold or in some cases used.   

The seller must provide the following "minimum documentation" to the buyer. It must provide proof that the project exists. This proof could come from a third party, like a county board or other government entity, a utility or an insurer. The seller must also provide documents substantiating that the project is exempted from or has complied with the wage and apprentice requirements and that it qualifies for any bonus tax credits included in the sale. (For more detail about those requirements, see "IRS Issues Wage and Apprentice Requirements" here, "Energy Community Bonus Credit Guidance" here, and "Domestic Content Bonus Credit" here.) Finally, the seller must provide evidence of qualifying costs, sales or other activities that determine the amount of the credits.

The buyer must keep the minimum documentation for as long as there could be an IRS audit adjustment.

Tax Consequences

The seller does not have to pay federal income taxes on the sales proceeds. The proceeds are treated as tax-exempt income.

If the seller is a partnership, the tax-exempt income is allocated to partners in the same ratio as the sold tax credits would have been allocated to the partners. This income pushes up partner capital accounts and outside bases. Then when the cash sales proceeds are distributed to the partners, the distributions reduce partner capital accounts and outside bases.

However, if the partnership only sells the tax credits belonging to one of the partners, then the tax-exempt income can be allocated solely to that partner and the cash from the tax credit sale can be distributed to it.

The cash sale proceeds do not have to be distributed to partners in the same ratio as they are allocated tax-exempt income. There are no restrictions on how the seller uses the cash.  

The buyer cannot deduct its purchase price.

Payment of the purchase price by a partnership buying tax credits is considered a "section 705(a)(2)(B) expenditure" that does not affect partner capital accounts or outside bases.

The Treasury has not decided yet whether the buyer should roll its transaction costs into the tax basis in the tax credits it purchased. That would not allow the buyer to deduct them.

A buyer who pays 92¢ for a dollar of tax credits has an economic gain of 8¢ when it uses the tax credits to pay a tax liability to the government. The buyer does not have to report this gain as income.

The buyer can take tax credits that it has purchased or intends to purchase into account when making quarterly estimated tax payments during the year. It does not have to wait for the tax credits actually to transfer. However, it is responsible for any underpayment of estimated taxes.

A buyer should check the tax year of the seller. Suppose the seller uses a tax year that ends in June and the buyer uses a calendar year. The seller sells tax credits to which it was entitled during the period July 2023 through December 2023. The buyer must use them in its 2024 tax year.  If the buyer and seller have different tax years, the buyer uses the tax credits in its tax year that started in the seller's tax year but ends after.

The seller can only sell tax credits to which it is entitled. For example, an investment tax credit cannot be claimed on a project that is leased to, or otherwise used by, a tax-exempt or government entity.

The buyer may be hampered in its ability to use the tax credits it purchases. For example, tax credits can only be used to reduce income taxes in a year by up to 75%. A buyer must treat purchased tax credits as passive investments. An individual can only use such tax credits to offset taxes on income from other passive investments. Portfolio income, like dividends and interest and capital gains from most stock investments, are not considered passive income for this purpose.

The Treasury is seeking comments about whether there are circumstances where an individual should be able to use purchased tax credits to offset other income.

The sale proceeds are not passive income to the seller.

Partnerships selling investment tax credits must ask their partners who are individuals, S corporations or closely-held C corporations whether they used nonrecourse debt to make their investments. (A closely-held C corporation is a corporation in which five or fewer individuals own more than half the stock.) If yes, then the partnership must work through at-risk limits in section 49 of the US tax code that may limit the ability of the affected partner to claim tax credits from the partnership. These limits are easy to avoid, but if the debt is not properly structured, they will reduce the amount of investment tax credits that the partnership is able to sell.

Any limit is calculated as of the end of the partnership tax year in which the project is placed in service.

Basically, the partnership would be limited to tax credits calculated on the equity that the partners have in the project.

As nonrecourse debt is paid down over time, equity builds and the partnership would be entitled to more tax credits. However, any such additional tax credits will go to the affected partners. Any such additional tax credits cannot be sold.

A subtlety in partnership accounting should be reflected in any financial model where tax credits are sold by a partnership. Suppose a 50-50 partnership is entitled to a $1 tax credit that it sells for 90¢. The partnership has 90¢ in tax-exempt income. Each partner is allocated 45¢ in income and is distributed the same amount in cash. However, the depreciable basis that the partnership has in the project must be reduced by half the $1 tax credit, or by 50¢. The partner outside bases are also reduced by 50¢.

Recapture

Investment tax credits are recaptured if there is a "disposition" of the project within five years after it is placed in service. The investment credits vest ratably over the five years. Thus, if in year two the owner sells the project or distributes the project to its partners or shareholders or the project suffers a casualty, then 80% of the tax credit -- the amount that is unvested -- must be repaid to the US Treasury.

If this happens to a project on which tax credits were sold, the seller must inform the buyer. The buyer must then calculate the recapture liability and let the seller know. The buyer must then repay the Treasury.

The seller increases its depreciable basis in the project by half the recaptured investment tax credit and is entitled to more depreciation.

This will frustrate buyers for two reasons. They will end up having paid the seller for the tax credit and also have to pay the Treasury. The seller has control in most cases over whether recapture will occur. The buyer has no control.

The seller must notify the buyer of the recapture event, and the buyer must notify the seller of the recapture amount, in time for each to take the information into account by the due date -- without extensions -- for its tax return for the recapture year.

Normally, investment tax credits on a project owned by a partnership are also recaptured if a partner sells its partnership interest or its share of partnership income is reduced by more than a third within the first five years after the project is placed in service. Only the unvested tax credits are recaptured. The tax credits that were allocated to that partner are recaptured at the partner level. In cases where the tax credit is sold, the partner in the seller partnership would owe the Treasury the recapture amount. There is no need for the partnership to inform the buyer and no liability for the buyer.

Production tax credits for capturing CO2 emissions can be recaptured if the captured CO2 that has been sequestered leaks from underground storage within three years. The IRS section 45Q regulations require the company capturing the CO2 to reduce the tax credits to which it would otherwise be entitled to claim on CO2 captured in the leak year by the tax credits on the leaked CO2. Thus, if the capture company would be entitled to $100 in tax credits in year 3, but CO2 on which $5 in tax credits were claimed leaked that year, the capture company would only be able to claim $95 in tax credits in year 3.

However, the proposed transferability regulations require the tax credit buyer to repay the Treasury for the tax credits on the leaked CO2. Presumably the capture company will not have to reduce its year 3 tax credits. Otherwise, there will be double recovery by the government.

Disallowance

Congress was concerned about inflated tax bases used to calculate investment tax credits.

The Inflation Reduction Act authorizes the IRS to collect a penalty of 120% of any excessive tax credit claimed where part of the tax credit is later disallowed for any reason, and not just due to an inflated tax basis.

The proposed transferability regulations make the tax credit buyer responsible for the penalty.

It can avoid the extra 20% penalty, but not the obligation to repay the disallowed tax credit, by showing it had reasonable cause to claim the full tax credit.

The most important factor when showing reasonable cause is the length to which the buyer went to confirm the seller was entitled to the tax credits it sold. The buyer must show it reviewed the seller's records relating to the tax credit amount, including wage and apprentice compliance or exemption and the grounds for claiming any bonus credits. It must have been reasonable to rely on any third-party experts who advised the buyer. For example, it may be unreasonable to rely on an aggressive or poorly reasoned tax opinion. The representations on which it relied from the seller must be credible. The buyer should review any audited financial statements filed by the seller with the US Securities and Exchange Commission.

The disallowance is charged first against any tax credit the seller retained. For example, suppose a company believes it is entitled to $100 in tax credits. It sells $50 and keeps $50. The IRS later disallows $50 in tax credits. There is no penalty on the buyer since its tax credits were not disallowed. The $50 in tax credits that the seller retained are disallowed. There is no penalty for an excessive tax credit transfer since the disallowed tax credits were not transferred.

If the company had sold $80 and kept $20 in tax credits, then the $50 disallowance will come first out of the $20 in tax credits retained by the seller and $30 in tax credits sold to the buyer. The buyer will owe 120% of $30, or $36, unless it can show reasonable cause to support the $30 it claimed. If it had reasonable cause, then it owes the IRS $30 for the disallowed tax credits, but not the additional $6.  

The seller must report any amount it was paid for disallowed tax credits as taxable income.

The IRS is on the lookout for transactions where sellers overcharge or undercharge for tax credits.

A seller may overcharge in an effort to avoid reporting the full purported purchase price as income when it was partly a payment for something else.

A seller may undercharge in an effort to give the buyer a larger tax deduction by making it look like part of what was really purchase price for tax credits was a deductible payment for something else like services.

Sale Mechanics

The seller must register the transaction on an electronic portal that the IRS is expected to open by year end. The IRS will assign a unique number to each transaction.

The seller must file an election with the IRS for each sale transaction on its annual tax return. It must already have registered the transaction so that it can include the registration number. The election must be on the seller's original tax return for the year. The seller cannot amend an already-filed return to make the election, and the IRS will not grant relief to sellers who miss the deadline.

A buyer, unlike the seller, can amend an already filed tax return to claim tax credits it purchased.

A separate registration and separate election must be made for each "facility" for each year tax credits will be claimed and for each buyer.

Batteries will require a separate election from a co-located solar or wind facility after the investment tax credit for storage facilities moves in 2025 from section 48 to section 48E of the US tax code.

The Treasury is considering whether a single election should be allowed for an entire "energy project" to be defined in future guidance.

If a project is owned by a partnership, the partnership makes the election. If the project is owned by a disregarded entity, the "regarded" parent makes the election. If it is owned by a corporation that is included in a consolidated return with other corporations, then the corporation that owns the project makes the election, although the consolidated parent usually acts as the agent for the individual group members.

In a sale-leaseback, any sale of tax credits is by the lessor, and the lessor makes the election.

Both the seller and buyer must attach a "transfer election statement" and an IRS Form 3800 to their annual tax returns for the tax credit year. The seller must also attach a form for the particular type of tax credit.

The "transfer election statement" must include the registration number for the tax credit sale. Both parties must acknowledge their obligations after any recapture of tax credits. Both must represent that the seller and buyer are not related to each other and that no other corporations with whom they join in filing consolidated returns are related. The seller must represent that it provided the buyer with the "minimum documentation."

The seller must report any change in facts between registering the transaction and making the tax credit sale election on its annual tax return. An example is where the project is sold to a tax equity partnership that then sells the tax credits. The transaction might have to be re-registered and a new registration number assigned before an election can be made to transfer the tax credits. Timing could be a concern given the hard-and-fast deadline to file the election.