IRS Wraps Up Green Energy Tax Credit Transfer Rules, Explained

Final rules from the Treasury Department governing energy tax credit transfers cement guidance for one of the bigger changes to come out of the 2022 tax-and-climate law known as the Inflation Reduction Act.

The IRS and Treasury finalized proposed rules issued last June over how eligible taxpayers can effectively buy or sell certain energy tax credits, and clarify who is eligible to monetize the credits and how credits can be transferred. Transferability is expected to bring in a wider array of buyers and capital into clean energy financing.

The market for tax credit transfers has already exploded, with billions of dollars in deals done and tax credits selling for upwards of 96 cents on the dollar in ideal circumstances. Here’s what you need to know about the energy tax credit transfer rules.

1. Why are tax credit transfers important?

Allowing tax credit transfers has been a game changer in the renewable energy space, especially for smaller players who lacked the resources to pursue complicated tax equity deals.

Unlike tax credit transfers, tax equity deals require a green energy developer and its investors to form a partnership—coming to terms with how to distribute the credits and how to shift ownership when the deal is done. There are many ways to do this; all require professional help to structure and complete the due diligence needed to make sure it’s executed correctly.

Tax credit transfers on the other hand are much simpler, and essentially amount to selling a credit to an investor for cash—although it still requires careful planning and due diligence.

Early on, some speculated that credit transfers would replace tax equity deals as the main way companies monetized energy tax credits. That hasn’t panned out.

Tax equity deals allow the parties to monetize the depreciation of the asset as well as the credit—meaning those who choose to do a credit transfer deal are leaving money on the table. And investors in tax equity deals have found they have more flexibility to transfer credits, making them more attractive to do.

2. What stands out in the final regulations?

The IRS maintained much of the proposed rules, rejecting a number of suggestions on hot button issues such as whether wealthy individuals can buy credits—they generally can’t—and how to structure deals with bonus credits included.

“I was a little disappointed. There were a lot of well-reasoned comments that I thought would move them a little more,” said Dustin Stamper, tax legislative affairs practice leader at Grant Thornton LLP. “They rejected most of the comments in some pretty key areas.”

In comments and hearings, taxpayers asked that they be able choose who gets the bonus credits—such as domestic content or prevailing wage adders—in deals where they’re selling only a portion of the credits received for a project to a buyer, instead of splitting the base credits and the bonus credits proportionately.

It’s harder to do due diligence on bonus credits, and they have a higher risk of being disallowed under audit because the rules around them are less clear and they often require working with third parties to verify required information.

The IRS rejected that request, saying it would be too burdensome for agency auditors and that each party would have to take a proportionate share of each type of credit.

The IRS also kept in a prohibition on advanced payments for credits, rejecting requests to allow buyers to pay for credits in the years before a credit is generated in the hopes of making it easier to use credit transfers to finance the development of renewable energy projects.

3. Will the rules impact the energy tax credit transfer market?

Not really.

Many of the topics in contention, such as eligibility of wealthy individuals and how to include bonus credits in sales, were expected to fall the way they did.

Prices for credits have been high, ending last year near 95 cents on the dollar, reflecting high demand and investor confidence that the claimed credits will stand, said Keith Martin, head of US projects for Norton Rose Fulbright US LLP Co.

Prices are largely impacted by the amount of risk in a deal as well as the demand across the market. Prices have since dipped to 90 cents to 93 cents on the dollar, he said, though he expects that to tick up later this year as corporate tax departments focus on ways to bring down next year’s tax bills.

These final rules could improve demand for the credits, reducing risk and potentially bringing prospective buyers off the sidelines, said Carina Federico, a partner at Crowell & Moring.

“Corporates are trying to de-risk the investment as much as possible. Final regs really give certainty to some of the aspects, and as the market grows they’ll be more comfortable entering,” she said. “So I think that’s where the hesitancy has been. From what we’ve seen, some of the large corporates don’t want to take on the risk necessarily right now, but this will help move the industry along.”

4. Will more companies take part now that final rules are out?

The market for tax credits is expected to continue to grow, said Alfred Johnson, CEO of Crux, which provides an online marketplace for transferable tax credits.

His company estimated that between $7 billion and $9 billion in energy tax credit transfers took place last year, a number he said must multiply to meet the program’s goals.

Companies and their advisers continue to get better at structuring deals and attracting new investors to the space, Johnson said, and they continue to see newcomers to the space, including smaller companies and eligible family offices, in addition to the banks and other traditional tax credit buyers.

“Now that we have final guidance that confirms many of the positive aspects of the proposed guidance, that market will continue to grow rapidly,” Johnson said.

Read more:

• Treasury Issues Final Rules for Energy Credit Transfers
• NextEra Inks $1 Billion Green Energy Tax Credit Transfer Deal
• Electric Vehicle Tax Credit Applications Pour In to Treasury
• Treasury Finalizes Direct-Pay Rules for Energy Tax Credits
• Biden Unveils Winners of $2 Billion in Green Tax Credits
• Hydrogen Tax Credit Rules Must Sync With Biden’s Climate Agenda (Insight)