6418 Proposed Regulations for Transferring Tax Credits

The Inflation Reduction Act of 2022 created Section 6418, which for the first time permits the transfer of certain clean energy tax credits to other taxpayers for cash. This provision is designed to help project developers monetize tax credits they might not otherwise be able to use, offering an alternative to complex financing. The U.S. Department of the Treasury and the Internal Revenue Service (IRS) have since issued final regulations, effective July 1, 2024. These rules establish the framework for how credit transfers must be executed, defining who can participate and the steps they must follow.

Key Definitions Under the Proposed Regulations

The regulations define the parties involved in a tax credit transfer. An “eligible taxpayer” is any taxpayer subject to U.S. federal income tax. However, governmental or tax-exempt entities are not considered eligible taxpayers because they have a separate direct pay mechanism available. For-profit entities, including partnerships and S corporations, are the primary group eligible to sell their credits.

A “transferee taxpayer” is the entity that purchases the credit and cannot be related to the seller. The concept of being “related” is based on Internal Revenue Code rules preventing transfers between entities with common ownership or control to ensure transactions are at arm’s length. The transferee acquires the credit to apply against its own federal tax liability.

Eleven “eligible credits” aimed at clean energy and advanced manufacturing can be transferred. These include:

• Production Tax Credit (PTC) under Section 45
• Investment Tax Credit (ITC) under Section 48
• Carbon oxide sequestration credit under Section 45Q
• Clean hydrogen production credit under Section 45V
• Advanced manufacturing production credit under Section 45X
• Alternative fuel vehicle refueling property credit under Section 30C
• Zero-emission nuclear power production credit
• Clean electricity production credit
• Clean fuel production credit
• Qualifying advanced energy project credit
• Clean electricity investment credit

Taxpayers must transfer a “vertical slice” of the credit. This means they cannot separate and sell only bonus credit amounts; the transferred portion must include a proportionate share of both the base credit and any associated bonus credits.

The Transfer Election and Registration Process

A required step for any credit transfer is the pre-filing registration process. Before a transfer can be made, the eligible taxpayer must register the credit-generating property with the IRS through a dedicated electronic portal. This submission requires specific information, such as the type of eligible credit, the physical location of the property, and its estimated credit amount. This system allows the IRS to track each credit, and upon successful registration, the IRS issues a unique registration number.

This registration number is required for a valid transfer and must be obtained before filing the tax return where the transfer is reported. Following registration, the transaction is formalized with a “transfer election statement.” This statement must be attached to the tax returns of both the seller and the buyer. It must include the registration number, names and taxpayer identification numbers of both parties, a description of the credit, and the cash amount paid.

The election to transfer a credit is irrevocable. It must be made on an original, timely-filed tax return (including extensions) for the year the credit is determined. The election cannot be made or changed on an amended return or through an administrative adjustment request.

Tax Consequences for the Transferor and Transferee

For the eligible taxpayer selling the credit, the cash received as consideration is not included in gross income and is therefore exempt from federal income tax. Concurrently, the seller is not permitted to claim a deduction for any expenses related to the transaction that would otherwise be deductible. The exchange is that the seller forgoes claiming the tax credit on its own return in exchange for tax-free cash.

For the transferee taxpayer buying the credit, the cash paid is not a deductible business expense. The transferee treats the expenditure as the purchase price of a tax asset and claims the purchased credit on its own tax return, often on Form 3800, General Business Credit, to offset its tax liability. The transferee takes the credit into account in its first taxable year that ends with, or after, the taxable year of the seller in which the credit was originally determined.

A purchased credit is subject to the same tax rules and limitations that would have applied to the original seller. For instance, the credit is still subject to passive activity rules under Section 469, which could limit its use if the transferee does not materially participate in the activity. The buyer is responsible for analyzing its own tax situation to ensure it can use the purchased credit.

Special Provisions and Anti-Abuse Rules

The regulations address credit recapture risk by placing the liability on the transferee taxpayer. Recapture can occur if the property that generated an Investment Tax Credit is disposed of or stops qualifying within a five-year period. If a recapture event happens, the buyer, not the original seller, is responsible for the resulting tax increase. The original seller must notify the buyer of any such event.

The regulations provide specific guidance for pass-through entities like partnerships and S corporations. The election to transfer a credit must be made at the entity level, not by individual partners or shareholders. The tax-exempt income from the sale is then allocated among the partners or shareholders, allowing the economic benefit to flow through to the owners without being subject to federal tax.

Two limitations are in place to protect the market’s integrity. First, a credit can only be transferred once, which prevents a secondary market from forming. Second, a broad anti-abuse provision allows the IRS to disallow a transfer if its main purpose is tax avoidance rather than facilitating clean energy investment.