Treasury Department and IRS Issue Final Regulations Regarding the Transferability of Tax Credits Under Section 6418 of the Internal Revenue Code

Proposed and temporary regulations relating to the transferability of such tax credits were issued by Treasury and the Internal Revenue Service (IRS) on June 14, 2023, and were published in the Federal Register on June 21, 2023 (the “Prior Regulations”). After consideration of numerous comments submitted by interested parties with respect to the Prior Regulations, Treasury and the IRS issued final regulations on the transfer election on April 25, 2024, which were published in the Federal Register on April 30, 2024 (the “Final Regulations”). In large part, the Final Regulations adopt the Prior Regulations, but some changes were made in response to comments received by Treasury and the IRS.

High-Level Overview of Significant Aspects of the New Guidance on Transferability of Certain Energy Credits

Original Return Requirement. Under the Final Regulations, a transfer election must be made on an original federal income tax return filed no later than the applicable due date (including extensions) for the relevant taxable year. A transfer election also may be made on a superseding tax return filed within such time period. A direct pay election may not be made for the first time, however, on an amended return or by way of an administrative adjustment request (AAR). No late election relief is available under Treasury regulation Section 301.9100-1 or 301.9100-3.

Correction of Numerical Errors. Despite the original return requirement, the Final Regulations allow for the correction of numerical errors by filing amended returns or AARs. Corrections are not permitted, however, for items left blank or responses of “available upon request.” Any amendment that reflects a decrease in the amount of the eligible credit first reduces any eligible credit retained by the transferee, and then reduces the eligible credit transferred (on a pro rata basis in the case of multiple transferees).

No Advance Payments. Payments of cash consideration for the transfer of eligible credits must be made during the period beginning on the first day of the taxable year of the transferor in which the eligible credit is determined and ending on the due date for the filing of the transfer election (i.e., the due date for the transferor’s federal income tax return, including extensions). Parties may contractually agree on the sale of eligible credits in advance of the time at which the eligible credits are generated, but advance payments of cash are not permitted by the Final Regulations. Treasury and the IRS did note, however, that a transferor is free to obtain third-party loan financing secured by such a contractual commitment to sell eligible credits, as long as the loan is respected as indebtedness from a federal income tax standpoint.

Transfer Election Statement. In order to make a valid transfer election, the Final Regulations require the filing of a “transfer election statement” with the original federal income tax return of the transferee, signed under penalties of perjury by the transferor and including the written consent of the transferee. The Final Regulations do not prescribe a particular form for the transfer election statement, indicating as an example that the relevant purchase and sale agreement could be used, as long as it meets all the requirements and is labeled “Transfer Election Statement” for filing purposes. Among the requirements for the transfer election statement is an attestation that certain documentation has been provided by the transferor to the transferee, specifically including (i) information that validates the existence of the eligible credit, (ii) documentation that substantiates the satisfaction of all requirements for any associated bonus credits and (iii) evidence as to the qualifying costs included in any investment-based credit, or as to the qualifying production activities and sales amounts included in any production-based credit (“required minimum documentation”). Some commenters had suggested that more robust documentation should be required, such as documentation relating to compliance with applicable labor laws. Treasury and the IRS declined to change the required minimum documentation as provided in the Prior Regulations, noting that the transferee is not precluded from insisting on more diligence documents as part of the negotiation of a credit transfer transaction.

Registration Requirements. The Prior Regulations included detailed provisions requiring taxpayers to apply with the IRS for a registration number for eligible credits and the reporting of the registration number in connection with a transfer election. A number of commenters advocated for streamlining the pre-filing registration process for various reasons, and also for a set time limit for the IRS to approve the registration and provide the required registration number. Treasury and the IRS rejected these suggestions and adopted the Prior Regulations relating to the pre-filing registration process without change, emphasizing that the registration of eligible credits was necessary to prevent fraud and abuse. Treasury and the IRS did agree, however, to continue to monitor the pre-filing registration process to determine if improvements in efficiency can be made. With respect to the timing of registration approvals, Treasury and the IRS referred to Publication 5884, relating to guidance on pre-filing registrations, which recommends applying for registration numbers at least 120 days prior to the anticipated filing of the tax return on which a transfer election will be made.

Bonus Credits. The Final Regulations provide that, where applicable, the amount of an eligible credit includes any associated bonus credits, such as those granted with respect to use of domestic content or location in an energy community. As a result, while a partial sale of eligible credits is permitted pursuant to a transfer election (i.e., a “vertical” separation of eligible credits), any such sale must include a proportionate share of any bonus credits. Some commenters had advocated for the ability to sever bonus credits from the relevant eligible credit as a way to increase flexibility and marketability of credit transfers, but such a “horizonal” separation of eligible credits is not possible under the Final Regulations.

Passive Activity Limitations. Consistent with the Prior Regulations, eligible credits purchased by a transferee are treated as related to a trade or business and, thus, subject to the passive activity limitation of IRC Section 469 in relevant situations. Furthermore, the Final Regulations provide that a transferee cannot be considered an owner of the trade or business of the transferor so as to potentially qualify the purchased credits as non-passive by applying the “grouping” rules under Treasury regulation section 1.469-4(c), except in the limited situation where the transferee also owns an interest in that trade or business (but is unrelated to the transferee for purposes of IRC Section 6418). As a result, individuals and closely-held corporations likely cannot take advantage of eligible credits acquired by way of a transfer election.

Excessive Credit Transfers. IRC Section 6418(g)(2) provides rules for dealing with transfers of eligible credits that exceed the amount of credits allowable for federal income tax purposes (“excessive credit transfers”), which include a potential 20 percent penalty absent a showing of reasonable cause. The Final Regulations provide guidance relating to excessive credit transfers that are substantially consistent with the Proposed Regulations. Under the Final Regulations, amounts received by a transferor in respect of an excessive credit transfer are not excluded from gross income by reason of IRC Section 6418(b)(2), and in a clarification to the Prior Regulations, such amounts are not precluded as a deduction to the transferee under IRC Section 6418(b)(3).

Partnership Applicability. Under the Final Regulations, a partnership’s election to sell eligible credits is made at the partnership, not partner, level. However, partnerships transferring a portion of an eligible credit are able to allocate any remaining credit amounts to specific partners while also allocating the tax-exempt income attributable to such transfer to other partners. Other than under this special rule, the related tax-exempt income is allocated to partners in the same proportions as the underlying credit would be allocated.

Partnership and S Corporations Purchase of Credits. Both partnership and S corporations are eligible to purchase eligible credits under the Final Regulations. For a partnership, the cash used to purchase an eligible credit is considered a nondeductible expenditure under IRC Section 705(a)(2)(B). The eligible credits are allocated based on each partner’s distributive share of non-deductible expenses. The distributive share of such non-deductible expenses is determined in accordance with the partnership agreement or based upon the partnership’s general allocation of non-deductible expenses. S corporations treat the cash payment used to purchase a credit as a non-deductible expenditure under IRC Section 1367(a)(2)(D) and must allocate the cash used and the credit purchased on a pro rata basis.

Chaining. The Final Regulations do not address the possibility of making a “direct pay” election under IRC Section 6417 with respect to eligible credits that are purchased pursuant to a transfer election (i.e., “chaining” of credits). Chaining was stated as being beyond the scope of the Final Regulations, and instead as an issue that must be resolved under IRC Section 6417. Additionally, Treasury and the IRS pointed to recently issued IRS Notice 2024-27, which requests comments on various questions relating to chaining, including as relates to statutory interpretation of IRC Sections 6417 and 6418, potential impact on the tax credit transfer marketplace and administrability challenges.

Final Points
As the Final Regulations are substantially consistent with the Prior Regulations, the Final Regulations are probably more noteworthy for the issues that were not addressed and the comments that were rejected. The Final Regulations are effective July 1, 2024, and generally apply to taxable years ending on or after April 30, 2024. Taxpayers are permitted to apply the Final Regulations to prior taxable years as well, provided the Final Regulations are applied in their entirety and in a consistent manner.