The Inflation Reduction Act of 2022 added Section 6418 to the Internal Revenue Code (the “Code”) to allow taxpayers to sell certain Federal income tax credits.

These tax credits include:

• production tax credits for qualified clean hydrogen facilities (§45V)
• manufacturing tax credits for clean energy components (§45X)
• production tax credits from clean energy sources (§45Y) 
• investment tax credits for clean energy generation and storage technologies (§48E)

On April 30, 2024, the Internal Revenue Service (“IRS”) formally published final regulations governing the transfer of certain Federal income tax credits under Section 6418 of the Code (84 Fed. Reg. 34770-34816) (the “Final Regulations”). These Final Regulations will be effective on July 1, 2024.  Note that, prior to the issuance of these regulations, taxpayers operated under the temporary regulations the IRS issued on June 21, 2023. On that date the IRS also published proposed regulations for the transfer of tax credits and solicited public comments thereon.

Key Notes from the Final Regulations

1. Derivative Instrument Sales Are Not Transfers – Under the Final Regulations tax credits may only be transferred once. However, contracts for the sale of tax credits may be assigned because such derivative instruments are not actual transfers.
2. A Transferee Who Participates Wins – The Final Regulations denied transferees a carveout for Section 469 passive loss rules. However, a transferee that “materially participates” in the tax credit generating activity in accordance with Section 469(h) of the Code and owns an interest in the generator may purchase the generated tax credits and treat the credits as though they did not arise in connection with a passive activity. Under Section 469(h) a taxpayer materially participates in an activity if its involvement in the activity is regular, continuous, and substantial. The IRS uses several tests to determine whether these requirements are met.
3. Credit Adjustments Must Be Made with Precision – An increase in tax credits must be shown on the credit source forms - such as Form 3800 - and the transferor’s amended tax return or administrative adjustment request. A decrease in tax credits transferred must be shown on the same forms as well as the transfer election statement.
4. The Final Regulations Clarify Anti-Abuse Rules – Here, the revised language broadens the IRS’s power to disallow a transfer. The proposed regulations would have disallowed a transfer under Section 6418 of the Code if the principal purpose of the transfer was to avoid tax liability beyond the tax credit transfers allowed by Section 6418. Under the Final Regulations, the IRS would disallow a transfer if such intent formed any one of the principal drivers behind the transfer. The Final Regulations also replace references to average transfer prices in proposed pricing examples with “arm’s length price” language. An “arm’s length” price is calculated without considering other commercial relationships between the parties. In the background section of the Final Regulations the IRS noted that it may be difficult to establish average market pricing because data may not be available for some time.
5. A Disallowance First Reduces Credits Retained by the Transferor – Pursuant to Section 6418(g)(2)(A) of the Code, a disallowance due to an “excessive credit transfer” shall first reduce the seller’s retained credits before it reduces the credits transferred to a buyer. An excessive transfer occurs when a transferee taxpayer claims more credits than were allowed to the transferor payer under Section 6418. The IRS charges the excess amount as a tax, plus a 20% penalty.
6. The Treasury Ordering Rule Does Not Apply to Recapture Events – Under the Final Regulations, recapture liability is shared by the transferor and transferee pro rata. Unlike a disallowance, credits subject to a recapture initially existed, but were lost due to a subsequent event. The transferee’s recapture liability is equal to the portion of the tax credits transferred, and the transferor’s liability is equal to the portion retained.
7. Eligible Credits May Not Be Separated into Base and Bonus Credits for Transfers – The Final Regulations confirm that a transfer of an entire eligible credit, or a portion of an eligible credit, must include a proportionate share of any bonus credit. A taxpayer may not sever bonus credits from a transfer.

Final Regulations Answer Important Return and Recapture Questions

The Final Regulations answer important questions about amended tax returns and partner-level recapture rules. Under the proposed regulations it was unclear whether transferor taxpayers could make a transfer election on amended and superseding returns. The Final Regulations resolved this ambiguity by clarifying the election rules. Under the Final Regulations, a transferor may make the transfer election on an initial or superseding return. However, transferors may not make the transfer election on an amended return. The Final Regulations do allow transferor and transferee taxpayers to revise completed numerical fields on a previous return with an amended return, so long as they are not filling-in previously blank fields. Transferor taxpayers should therefore make the election on their initial return or a superseding return, and transferee taxpayers should require proof thereof. The Final Regulations also discuss the effect of a partner-level recapture event on the remaining amount of recapture liability for which the transferee taxpayer and the transferor partnership are responsible. The Final Regulations reflect the Treasury Department and the IRS agreement that a single credit should not be subject to duplicate recapture. The Final Regulations therefore clarify that, to the extent a partner in a transferor partnership is liable to recapture under Sections 50(a) or 49(b) of the Code, that partner’s recapture liability does not result in recapture liability to a transferee taxpayer pursuant to Section 6418-3(a)(6). The amount of the partner’s recapture liability reduces the remaining amount of credits subject to recapture for a recapture event caused directly by the transferor partnership.

The Regulations Are Final But Several Questions Remain

Although the Final Regulations answered several material questions, the IRS adopted most of the proposed regulations that initially created the underlying confusion. The Final Regulations therefore inherit several gray areas from the proposed regulations. Among these are the form of the transfer election statement and the timeline for obtaining a registration number from the IRS. To make a valid transfer election, a tax payer must include the following with its annual tax return: (1) a completed source credit form for the eligible credit; (2) a properly completed Form 3800; (3) a schedule attached to the Form 3800 showing the amount of eligible credit transferred for each eligible credit property, except as otherwise provided in guidance; (4) a transfer election statement; and (5) any other information related to the election specified in IRS guidance. Both the proposed and Final Regulations describe the information that a transfer election must include, but the IRS did not provide an example form of the transfer election statement in either set of regulations. Instead, the IRS has taken the position that “any document” can serve as a transfer election statement if the document otherwise meets the requirements of Section 6418-2(b)(5)(i) and includes the required information. Although Taxpayers are now free to draft transfer election statements in a variety of forms, we may not discover the limits of this freedom until the IRS begins rejecting transfer election statements.

Section 6418 of the Code requires taxpayers to use the IRS pre-filing registration process to register qualified investments in an eligible facility. The IRS reviews the registrations and issues registration numbers for the facilities. It will then match registration numbers with transferee taxpayers that claim credits against their tax liability. Although commenters requested a set timeline for registration approval and an efficient review process, the IRS declined to formally include either mechanism in the Final Regulations. The IRS has agreed to continually review the registration process for efficiency improvements. It also encourages taxpayers to apply for registration numbers at least 120 days prior to filing their tax return that will include an election transfer statement.

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