Inflation Reduction Act: Credit monetization proposed regulations create strategic opportunities

In brief

The Inflation Reduction Act of 2022 (Act) created, extended, and expanded certain tax credits intended to encourage production of clean energy, reduce carbon emissions, and promote domestic manufacturing. Many of these credits provide a base rate and then increase the base rate for compliance with certain social policy-related requirements, such as prevailing wage, domestic content, and location-based (credit bonuses).  

Observation: This presents a strategic opportunity for companies and asset managers with a presence in the United States, including those with a focus on infrastructure, real estate, and private equity. Initially estimated at $370 billion in new energy-related tax credits over the next 10 years, recent estimates have doubled as participants and new entrants to the market realize the breadth of credits available.  

Additionally, the Act creates mechanisms to allow a broader spectrum of taxpayers to benefit from the credits, either through an elective payment (as referred to in the latest proposed regulations, and previously ‘direct pay’ or ‘refundability’) under Code Section 6417 or a transferability election under Section 6418. On June 14, the IRS and Treasury released three regulation packages addressing the elective payment and transfer of energy credits: temporary regulations requiring taxpayers to register on a portal when monetizing credits, proposed regulations on elective payment, and proposed regulations on transfers. Taxpayers should carefully consider the registration requirements in relation to both Section 6417 and Section 6418. The IRS also issued FAQs and a fact sheet providing information on the regulations. 

The temporary regulations apply to tax years ending on or after June 21, 2023. However, the proposed regulations state that a taxpayer may rely on the proposed regulations in tax years ending after December 31, 2022 but before publication of final regulations if it applies the proposed regulations consistently and in their entirety.  

Note: The IRS guidance provides a number of new details around important logistical elements of transferability. Both transferors and transferees should analyze the nuanced eligibility requirements for these credits in the year claimed and during recapture periods. For a broader discussion on the two proposed regulations and their interplay with the temporary regulation, please see our recent Insights linked below. 

Observation: One common credit monetization question for infrastructure, real estate, and private equity funds was how refundability and transferability would work in a partnership context since many partnerships are owned by both entities eligible for direct pay (i.e., tax-exempt) and entities eligible for transferability (i.e., taxable). In response, Treasury and the IRS indicated that the partnership is the relevant entity for these purposes. As a result, the proposed regulations provide that a partnership may monetize via direct payment only for credits related to clean hydrogen, carbon sequestration, and advanced manufacturing. For all other eligible tax credits, a partnership may only elect transferability, without regard to whether one or all of its partners are tax-exempt. 

Action Item: As the IRS is seeking to clarify the Act in a manner that reduces uncertainty, taxpayers have been provided the opportunity to comment on provisions in the Act that currently may not be clear. The IRS requests comments from the public by August 14, 2023 for both the Section 6417 and the Section 6418 proposed regulations. The public hearings on these proposed regulations are scheduled to be held on August 21 and 23, respectively.