Regulations on transfers of energy tax credits are finalized

In brief

What happened?

Section 6418 allows an eligible taxpayer to transfer certain energy credits to an unrelated party in lieu of claiming the credit. Regulations under Section 6418 were published on April 30 that finalize proposed regulations and remove temporary regulations that were published on June 21, 2023.

The final regulations apply to tax years ending on or after April 30, 2024. However, taxpayers may apply the final regulations, other than rules relating to pre-filing registration, in earlier tax years if they apply the rules consistently and in their entirety.

Why is this relevant

Section 6418, effective for tax years beginning after 2022, provides a new mechanism for taxpayers to monetize the benefit of an eligible credit, and a robust credit transfer market is developing. The final regulations adopt many of the proposed rules without change but clarify and modify some provisions, which will assist taxpayers to take advantage of these opportunities.

Action to consider:

Taxpayers that are considering purchasing tax credits should conduct due diligence for the investment, as credit eligibility largely depends on the activities of the transferor but the buyer is subject to the excessive credit transfer liability. Credits that involve prevailing wage and apprenticeship, domestic content, or recapture issues may present increased risk for a transferee if the credit is challenged by the government.

For more detailed information on credit transfers and the Section 6418 proposed regulations, see the PwC Insight Regulations address transfers of energy tax credits.

Final regulations

Credit property ownership

The proposed regulations provided that a credit is “determined with respect to” an eligible taxpayer if the taxpayer owns the underlying credit property “or” conducts the activities (such as production) that give rise to the credit, as required by the substantive rules for the specific credit. The final regulations specify that a credit is determined with respect to a taxpayer only if (1) the taxpayer owns the credit property “and” conducts the activities giving rise to the credit or (2) the taxpayer is considered under regulations to be the eligible taxpayer for the Section 45X credit.

Observation: The preamble to the final regulations advises that Section 45X is the only credit that does not require a taxpayer to own the credit property.

The proposed regulations defined eligible credit property under Section 45Q as a single process train of carbon capture equipment. The final regulations define Section 45Q credit property as a component of carbon capture equipment within a single process train.

Observation: The preamble to the final regulations explains that the revised rule clarifies that a taxpayer does not have to own an entire single process train to transfer the Section 45Q credit.

Anti-abuse rule

The proposed regulations included an anti-abuse rule disallowing a credit transfer, or recharacterizing a transaction as a credit transfer, if “the” principal purpose of the transaction is to avoid federal tax liability inconsistent with the Section 6418 statutory intent. The final regulations apply the anti-abuse rule if “a” principal purpose is tax avoidance and revise examples by substituting the language “arm’s length price” for “average transfer price.”

Transfers by disregarded entities

The proposed regulations provided that an eligible taxpayer may transfer an eligible credit for (1) eligible credit property held by a disregarded entity of which the taxpayer is the sole direct or indirect owner or (2) the taxpayer’s undivided share of eligible credit property co-owned as a tenant-in-common or through an organization that has made a Section 761(a) election to be excluded from the application of subchapter K. The final regulations add that a grantor of a grantor trust may be an eligible taxpayer and transfer credits for trust property the taxpayer is treated under Section 671 as owning.

Transferee’s tax year of credit

The final regulations add a rule specifying that, in determining the tax year that a transferee takes a credit into account, a 52/53-week tax year of an eligible taxpayer and a transferee taxpayer is deemed to close or end on the last day of the calendar month closest to the last day of the 52/53-week tax year.

Passive activities

The proposed regulations provided that the Section 469 limitations on claiming passive activity credits do not apply in determining the credit amount that an eligible taxpayer may transfer but may limit the credit that the transferee taxpayer may claim. In applying the passive activity rules, a transferee taxpayer was not considered to have owned an interest in the eligible taxpayer’s trade or business when work was completed and could not use the grouping rules to change the characterization of the transferee taxpayer’s participation. The final regulations further clarify that a transferee taxpayer that directly owns an interest in an eligible taxpayer’s trade or business at the time the work was done does not fail the Section 469(h) material participation requirements.

Time for election

The proposed regulations required a transfer election to be made on an original federal income tax return by the extended due date. An election was not permitted on an amended return or administrative adjustment. The final regulations adopt this rule; clarify that an initial election may be made on a superseding return, which is not an amended return; and add that an election may not be withdrawn through an amended return or administrative adjustment.

Observation: The preamble to the final regulations notes that the original return requirement applies only to the eligible taxpayer’s election. A transferee taxpayer may claim the credit on an amended return or administrative adjustment.

However, the final regulations allow a taxpayer to use an amended return or administrative adjustment to correct a numerical error, for example in the amount of the credit, in connection with an otherwise proper election, but not to supply information missing from the initial submission.

The final regulations specify the manner of reporting and the impact of certain corrections to numerical amounts. A decrease in the credit amount first reduces the amount of any credit retained by the eligible taxpayer and then reduces the amount reported by the transferee taxpayer or by multiple transferees on a pro rata basis. An eligible taxpayer must include in income after a credit reduction any retained consideration that does not relate to a transferred credit portion.

Under the proposed regulations, no late filing relief under Reg. 301.9100-1 was available for a credit transfer election. The final regulations provide six months late filing relief for taxpayers that failed to make the transfer election on their returns, but only for taxpayers that file their returns by the unextended due date.

Excessive credit transfers

The final regulations clarify that an excessive credit transfer amount is taxable to the transferor taxpayer and may be deducted by the transferee taxpayer.

The proposed regulations provided that a recapture event under Section 45Q or Section 50 is not an excessive credit transfer. The final regulations specify that a Section 49 recapture event also is not an excessive credit transfer.

Recapture

The proposed regulations provided that the transferee taxpayer is responsible for the tax resulting from Section 45Q or Section 50(a) recapture. The final regulations clarify that an eligible taxpayer that transferred only part of the total credit and retained a credit amount is responsible for a proportional amount of recapture.

The proposed and final regulations provide that a partner or S corporation shareholder in a partnership or S corporation that transferred a Section 48, 48C, or 48E credit may be required to recognize credit recapture upon disposing of its interest in the partnership or S corporation. The partnership or S corporation is not subject to recapture if it continues to hold the investment credit property. The final regulations add a clarification that the recapture amounts recognized by the partner or shareholder reduce the remaining potential recapture liability of the eligible and transferee taxpayers.

Real estate investment trusts

The final regulations add rules for real estate investment trusts (REITs), providing that (1) the value of an eligible credit that a REIT has not yet transferred is disregarded in determining the value of the REIT’s total assets and (2) a credit transfer is not a sale of property for purposes of the “seven sales” safe harbor.