On June 14, 2023, the Internal Revenue Service (IRS) published proposed regulations on the transferability of certain energy- and environmentally-related tax credits (the Proposed Credit Transfer Regulations). The Proposed Credit Transfer Regulations respond to the requests for guidance by businesses as to how to take advantage of Internal Revenue Code (IRC) section 6418, enacted as part of the Inflation Reduction Act of 2022, to transfer or acquire all or a portion of specific tax credits in certain circumstances. 

Very generally, the Proposed Credit Transfer Regulations provide detailed rules as to how taxpayers eligible to claim credits (eligible taxpayers) may transfer the tax credits permitted by section 6418 (eligible credits) for cash to unrelated buyers (transferee taxpayers).[1] Because the Proposed Credit Transfer Regulations are merely proposed regulations and are subject to revision in light of comments,[2] the rules in the final regulations may differ from those in the Proposed Credit Transfer Regulations. Nonetheless, the preamble to the Proposed Credit Transfer Regulations states that, until final regulations are issued, taxpayers may rely on the rules in the proposed regulations for taxable years beginning after December 31, 2022, as long as they follow the proposed regulation in their entirety and in a consistent manner. 

Although the Proposed Credit Transfer Regulations provide extensive guidance on how to apply the rules of section 6418 and the consequences of such transfers to both eligible taxpayers and transferee taxpayers, this alert focuses on only one aspect of the proposed regulations: what transferors and transferees of credits need to consider in drafting agreements to effect transfer of such credits. Of course, the rules set forth in the Proposed Credit Transfer Regulations will require the participants to revise other legal documents as well. For example, if the transferor or transferee is an S corporation or an entity treated as a partnership for federal income tax purposes, the S corporation’s operating agreement or partnership’s partnership agreement needs to be drafted so that it complies with the relevant rules of section 1.6418-3. 

Overview of the Proposed Credit Transfer Regulations

Only eligible credits may be transferred. These are the:

• Energy Credit of IRC section 48 (reflected in Form 3468, Part VI),
• Clean Electricity Investment Credit of IRC section 48E (reflected in Form 3468, Part V),
• Renewable Electricity Production Credit of IRC section 45 (reflected in Form 8835, Part II),
• Clean Electricity Production Credit of IRC section 45Y,
• Zero-emission Nuclear Power Production Credit of IRC section 45U (reflected in Form 7213, Part II),
• Advanced Manufacturing Production Credit of IRC section 45X (reflected in Form 7207),
• Clean Hydrogen Production Credit of IRC section 45V (reflected in Form 7210),
• Clean Fuel Production Credit of IRC section 45Z,
• Carbon Oxide Sequestration Credit of IRC section 45Q (reflected in Form 8933),
• Credit for Alternative Fuel Vehicle Refueling / Recharging Property of IRC section 30C (reflected in Form 8911, Part II), and
• Qualified Advanced Energy Project Credit of IRC section 48C (reflected in Form 3468, Part III).

The amount of eligible credit is separately determined with respect to each single eligible credit property. Proposed section 1.6814-1(d) defines eligible credit property as each of the units of property of an eligible taxpayer with respect to which the amount of an eligible credit is determined. More specifically, eligible credit property is:

• In the case of a section 30C credit, a qualified alternative fuel vehicle refueling property described in section 30C(c);
• In the case of a section 45 credit, a qualified facility described in section 45(d);
• In the case of a section 45Q credit, a single process train of carbon capture equipment described in section 1.45Q-2(c)(3);
• In the case of a section 45U credit, a qualified nuclear power facility described in section 45U(b)(1);
• In the case of a section 45V credit, a qualified clean hydrogen production facility described in section 45V(c)(3);
• In the case of a section 45X credit, a facility that produces eligible components, as described in guidance under sections 48C and 45X;
• In the case of a section 45Y credit, a qualified facility described in section 45Y(b)(1);
• In the case of a section 45Z credit, a qualified facility described in section 45Z(d)(4);
• In the case of a section 48 credit, generally an energy property described in section 48;
• In the case of a section 48C credit, and eligible property described in section 48C(c)(2); and
• In the case of a section 48E credit, a qualified facility as defined in section 48E(b)(3) or, in the case of a section 48E credit relating to a qualified investment with respect to energy storage technology, and energy storage technology described in section 48E(c)(2).

Specific rules must be followed in transferring credits. 

• The transferor must be an eligible taxpayer rather than an entity eligible to use the elective pay benefit of IRC section 6417.
• The eligible taxpayer (the transferor) and the transferee taxpayer must be unrelated.
• A credit may be transferred only for cash. This means that the payment must be made (1) by cash, check, cashier's check, money order, wire transfer, automated clearing house (ACH) transfer, or other bank transfer of immediately available funds; and (2) made within the period beginning on the first day of the eligible taxpayer's taxable year during which a specified credit portion is determined and ending on the due date for completing a transfer election statement.[3]
• The transferor and transferee taxpayer must agree on the credit being transferred. An eligible taxpayer may choose to transfer to the transferee taxpayer only a portion of an eligible credit generated from a single eligible credit property. Or, the eligible taxpayer may choose to transfer an eligible credit generated from a single eligible credit property to multiple unrelated parties in the same tax year.
• The transferor and transferee taxpayer must agree to, and file, a transfer election statement. Section 1.6814-2(b)(5) sets forth the requirements for a transfer election statement. Generally, the statement includes the name, address and taxpayer identification number for both the transferor and transferee, a description of the type and amount of the eligible tax credit transferred, the timing and amount of cash paid for the eligible tax credit transferred and the registration number related to the eligible credit property. It also includes certain statements and/or representations from the transferor and transferee.
• Both the transferor and transferee taxpayers must comply with the reporting and filing requirements of section 1.6814-2(b) generally, including attaching the transferee election statement to their returns.[4]

Provisions a Credit Transfer Agreement Will Need

To comply with the Proposed Credit Transfer Regulations, the agreement between the eligible taxpayer and the transferee taxpayers (the transfer agreement) will need to include certain specific provisions.

First, the agreement must clearly identify the specific credit being transferred and the amount of credit. (the specified credit portion). This specified credit portion will also be set forth in the transfer election statement, and the transfer agreement and transfer election statement need to be consistent in that regard.

Second the transferee taxpayer will expect the transferor to make certain representations, including that (i) the transferor is an eligible taxpayer and has a valid registration number with respect to the credit(s) being transferred and (ii) the property to which the credit is attributable is eligible credit property. 

The covenants and/or closing conditions in the transfer agreement should: 

• State that the transferor has completed (or will timely complete) electronic pre-filing with the IRS;
• State that the transferor is eligible to claim the credit being transferred;
• Provide the transferee taxpayer with the registration number and all other information necessary to claim the transferred eligible credit;
• Note that the parties have agreed to a transfer election statement or, if such a statement is not yet agreed to, require the transferor and transferee taxpayer to agree to a transfer election statement (and establish a mechanism for resolving disagreements so that the statement can be timely executed);
• If the eligible taxpayer is making multiple transfer elections, confirm that the aggregate amount of specified credit portions transferred with respect to the eligible credit property does not exceed the amount of the eligible credit determined with respect to the eligible credit property;
• Confirm that the credit being transferred is not with respect to any amount of eligible credit that is allowed for progress expenditures or that the credit has been determined in a manner other than as set forth in section 1.6418-2(d); and
• If the transferor or transferee taxpayer is a partnership or S corporation, comply with the relevant provisions of section 1.6418-3.

The parties to the transfer agreement should also consider the inclusion of provisions that deal with events that may occur post-closing. For example, it would be reasonable to require (i) the transferor and transferee taxpayer to file income tax returns consistent with the transfer election statement and the transfer agreement and (ii) the eligible taxpayer to renew pre-filing registrations as needed.

Depending on the credits being transferred, the parties will also need to address who bears the risk that the amount of credit that may be properly claimed by the transferee taxpayer is less than the amount of credit specified in the transfer agreement and how indemnification, if any, will take place. This is particularly the case regarding the risk of imposition of the excessive credit transfer tax and recapture of credits. 

• If the amount of credit claimed by the transferee taxpayer exceeds the amount of credit that would otherwise be allowable to that eligible credit property, then under section 1.6418-5 the transferee taxpayer generally is liable for the difference plus a 20% excessive credit transfer tax. Regardless of how the parties agree to allocate the risk of the excessive credit transfer tax, the transferee taxpayer will want the eligible taxpayer to cooperate and provide information so that the transferee taxpayer can assert a reasonable cause defense.[5] 
• Similarly, if the amount paid in the transfer agreement reflects the expectation of bonus credit amounts, the transferee taxpayer may want the transfer agreement to establish the standard of diligence the eligible taxpayer must undertake to meet the bonus credit amounts (i.e., best efforts, commercially reasonable). If the credit being transferred is subject to recapture (i.e., credits under Code sections 48, 48E or 48C or transferred carbon sequestration tax credits under Code section 45Q), the parties should consider how the eligible taxpayer will notify the transferee taxpayer of a recapture event and under what circumstances indemnification will occur. 

In short, the ability to transfer credits will create novel and unusual issues. It is best for both the transferor and the transferee taxpayer to anticipate as many of the issues as possible and address them explicitly in their transfer agreement.

[1] The Proposed Credit Transfer Regulations were released as part of a package of proposed and temporary regulations and FAQs which deal with other aspects of the tax credits adopted or expanded by the Inflation Reduction Act, such as “elective pay” and registration with the IRS. 
[2] The preamble requests comments by August 14, 2023.
[3] A transferee taxpayer may contractually commit to purchase eligible credits with US dollars in advance of the date a specified credit portion is transferred to such transferee taxpayer, provided the actual payment meets the requirements described above. 
[4] Note, however, that any amount paid to a transferor is not included in the transferor’s gross income. Further, the transferee taxpayer is not eligible to claim a deduction for any amounts paid for an eligible credit.
[5] Proposed Treas. Reg. section 1.6418-5(a)(4).