Exploring Transferable Tax Credits for Corporate Tax Environments
How the IRA empowers corporate tax departments to save up to 10% on federal income taxes.
The IRA greatly expanded energy-related federal income tax credits and added §6418 to the Internal Revenue Code, which allows “eligible taxpayers” to elect to transfer (i.e., sell) certain tax credits to unrelated taxpayers for cash.
Eligible taxpayers can elect to transfer all or a portion of an eligible credit, and the transferee taxpayer is treated as the taxpayer with respect to such credit (or such portion thereof). The transferee taxpayer is allowed to claim the transferred tax credits on their tax returns, while also assuming some risk in the event of a recapture event or a challenge by the IRS on the qualification of the transferred tax credit.
Tax credits can be transferred for tax years starting after December 31, 2022. The cash payments are excluded from the transferor’s gross income and are not deductible by the transferee.
Tax credits under the following U.S. tax code sections can be transferred: §45, §45Y, §48, §48E, §45Q, §45V, §45U, §45Z, §45X, §48C, and §30C. (To learn more about each credit, read our overview of the IRA's 11 transferable tax credits.)
How we got here
A small number of corporate taxpayers have traditionally helped project developers monetize investment tax credits (ITCs) and production tax credits (PTCs) through a process called "tax equity." This process is complex and requires a team of lawyers, accountants, and appraisers to help establish complicated partnership structures. As a result, the majority of capital that flowed into the $15B-$20B pre-IRA tax equity market was historically provided by a handful of large banks. Given the limitations on these banks’ tax appetite, something would need to change in order to attract capital for the IRA’s 10x or greater tax credit regime.
To address this challenge, Congress created a new monetization mechanism called transferability or transferable tax credits. Now, post-IRA, any company with federal income tax liability may use a standardized purchase and sale agreement to buy tax credits at a discounted rate, allowing them to earn a savings on their tax bill while also financing new sustainable infrastructure.
What corporate tax groups and sustainability teams need to know
By exchanging cash for transferable tax credits, a corporation could, for example, spend $45M for $50M of tax savings, realizing a $5M savings compared with paying their normal federal income tax liability.There are nine types of tax credits (across 11 sections of the tax code) now available for transferability. Companies can buy transferable credits from different technologies and project types. More established technologies are likely to be viewed as lower risk, whereas newer technologies may offer more attractive pricing.
Across these nine types of tax credits, several of them are categorized as “production tax credits” (PTCs) or “investment tax credits” (ITCs). This terminology refers to how the credit is generated–either as the item in question is produced (e.g. kilowatt hours of renewable energy) or as capital is invested in the associated project (e.g. a percentage of the cost of a solar farm). Tax groups will want to make strategic decisions about sourcing PTCs vs. ITCs or both, in order to secure streams of tax credits over time in the case of PTCs or one-off purchases in the case of ITCs. Intermediaries can help in structuring the procurement of these credits.
Timing and process
Some specifics of the transfer process are awaiting clarification from the Treasury department, but there are some things we already know from section 6418 of the U.S. tax code:
- Credits can be elected for transfer up to the time the seller files their tax return (Example: a credit generated in CY2023 can be transferred to a buyer until April 15, 2024 or October 15, 2024 for extended corporate filers)
- Credits can only be transferred in exchange for cash to an unrelated party
- Cash paid by the buyer is nondeductible
- Credits may only be transferred one time; resale of the credits is not allowed
- Buyers may carry back the credits up to three years, and carry forward the credits up to 22 years
The transactions themselves will be completed with a customized but relatively simple purchase and sale-style agreement. These should be constructed by experienced tax attorneys to ensure adequate protections for buyers and sellers, but are ultimately less complex than traditional tax equity partnership structures.
Transferable tax credits carry lower risk, in certain cases, versus traditional tax equity partnerships. For ITCs, a tax credit buyer is not concerned with the ongoing performance of the project beyond low-probability recapture events. And even for PTCs, the primary performance risk is related to the produced credit volume and not financial performance. The projects and developers associated with these credits should be vetted and underwritten to ensure credits are delivered as expected. For buyers of transferable credits, this review process can add certainty to reduce disallowance or recapture risk. Typically, buyers can also secure indemnifications from sellers to protect themselves in the event of recapture events. Transferable credits can also be insured against recapture, providing a backstop to indemnification.
Transferability represents a new pathway to access well-understood tax benefits for corporate taxpayers. By participating in the transferable tax credit market, companies can “do well and do good” by supporting renewable energy infrastructure and reduce their tax liability. Partnering with seasoned clean energy finance experts can help reduce risk and ensure a smooth, replicable transition process. For more information or to explore live project opportunities, please reach out to firstname.lastname@example.org.