Buying clean energy tax credits is the innovative way to generate a return on cash, boost your company’s earnings, reduce your effective tax rate, and support clean energy development.
Under the IRA, certain clean energy tax credits are now transferable.
When project developers generate more credits than they can utilize themselves, they are now allowed to sell those credits to third parties. The credits are typically sold at a discount which means a benefit to both parties. The developer monetizes tax credits that would have otherwise been unused, and the buyer realizes cash and financial statement benefits by purchasing the tax credits at a discount to their face value.
A body of rules and regulations have been issued to govern this process. To help summarize what those entail, below are answers to some of the most commonly asked questions.
Smith Dierking is ready to help you with these or any other questions you have. We will ensure you are comfortable in your understanding and confident in your decision as you step forward.
Q
What kinds of tax credits are involved?
A
These are transferable tax credits that are generated from various clean energy related initiatives.
The Inflation Reduction Act of 2022 (IRA) introduced Section 6418 which provided a new mechanism for monetizing certain tax credits. There are now 11 clean energy tax credits eligible to be sold for cash to an unrelated taxpayer, referred to generally as transferable tax credits. The most commonly transacted in the market are from qualified clean electricity investment (Sections 48/48E) and production (Sections 45/45Y) as well as from advanced manufacturing (Section 45X).
Q
Who can buy transferable tax credits (TTCs)?
A
The most common buyers are widely held C corporations.
For other buyers, such as individuals, estates, trusts, personal service corporations, and closely held C corporations (more than 50% owned by five or less individuals), note that final guidance provides no exemption from the passive activity loss rules of Section 469. Those rules generally limit the ability of these buyers to utilize credits. Taxpayers should consider the impact of Section 469 limitations before initiating a purchase.
Q
How much tax liability can be offset with TTCs?
A
Generally, up to 75% of federal tax liability can be offset.
Q
What are the rules on carryback and carryforward of TTCs?
A
TTCs can be carried back three years and carried forward 22 years.
Notably, when carrying back TTCs, credits must first be applied to the earliest year in the carryback period (three years before the current tax year). Any remaining unused credits can then be used for the year that is two years before the current year and then finally to the year before the current year.
Q
Can TTCs be resold?
A
No, TTCs may only be transferred once.
While the transfer is irrevocable and reselling is prohibited, buyers of TTCs have extended carryback (three years) and carryforward (22 years) periods available to utilize purchased credits.
Q
When can TTCs be applied against tax liabilities?
A
Buyers are allowed to consider, in determining estimated tax payments, TTCs they intend to purchase.
While buyers can offset quarterly estimated liabilities with TTC purchases they intend but have not yet completed, they remain liable for underpayments should the TTCs not be obtained as intended.
Q
How and when must TTCs be paid?
A
TTCs must be paid for with cash.
The buyer must make cash payments to the seller during the period that begins with the first day of the seller’s tax year in which the credit is determined and ends with the due date for the seller’s tax return, including extensions.
While buyers and sellers are allowed to agree on the sale of credits to be generated in future tax years, payments in advance of that period are not allowed.
Q
Why did the IRA include credit transferability?
A
A primary goal of the IRA is to accelerate the transition of the United States to greener, renewable energy sources. Prior to the IRA, the financing of clean energy projects was heavily dependent on tax equity structuring, which is a complex and expensive process that was dominated by a few very large participants.
Credit transferability democratizes the financing of clean energy projects, opening a way for far more participants to join in. Now project developers have even more options available as they plan their investments, eliminating potential bottlenecks in the system and speeding the deployment of clean energy projects.
Q
Is the purchase of TTCs a deductible expense?
Is the discount on the purchase taxable income?
A
No and no.
The purchase price of the TTCs is not deductible by the buyer (and is not taxable to the seller). Also, the discount received by the buyer on the purchased TTCs is not taxable to the buyer.
Q
How does pricing work?
A
The price for TTCs is typically expressed in terms of cents on the dollar of the face value of the credits. For example, TTCs being sold at a 5% discount are priced as $0.95.
The price on any particular TTCs is subject to negotiation and dependent on a number of factors. Considerations such as the type of credit, type of technology, project size, purchase amount, creditworthiness of the seller, presence of indemnities and/or insurance are among the factors with implications to the overall risk profile. The more risk involved, the greater the discount should be.
While there is variation to each unique purchase, a general price range to consider for TTCs is from $0.90 to $0.96.
Q
How do I measure my return?
A
For a simplified view on cash return, consider a purchase of $50 million of TTCs priced at $0.92. The buyer’s investment of $46 million cash ($50 million at 92 cents on the dollar) returns $4 million ($50 million face value at a cost of $46 million). A $4 million return on a $46 million investment is 8.7%.
More detailed calculations in determining rates of return on cash investment would include timing factors such as when payments are to be made by the buyer and when any required estimated tax payments are to be made. For example, a buyer could reduce Q1 estimated tax payments based on TTCs they actually pay cash for in Q4.
Other important measures of return could focus on the financial statement benefits, including the reduction in total tax expense recognized as the credits are utilized, along with the resulting decrease in effective tax rate and increase in net income.
In addition to quantitative returns, there are also the qualitative returns. Buying TTCs directly supports the development of clean energy projects, helping you to have impact well beyond simply managing your tax liability.
Q
What about transaction costs?
A
Transaction costs can include fees paid to advisors and intermediaries that conduct due diligence, facilitate transactions, and provide other services. Typically, these costs are paid for by the seller up to a negotiated cap amount. The cost of tax credit insurance, if any, is also typically paid for by the seller. The cost of the buyer’s advisor is typically included in the bid price for the TTCs. The gross price the buyer pays less all such costs determine the net price to be realized by the seller.
Q
What are the risks involved for buyers of TTCs?
A
Buyers of TTCs will need to understand what risks they face and how best to mitigate them. Some of the common sources of risk are project risk (related to timing of credit availability), disallowance risk (related to the amount of eligible basis), recapture risk (related to project operation period), and creditworthiness risk (related to strength of the seller’s guarantees or indemnities).
Smith Dierking works with buyers to help them mitigate risks at every step of the transaction process.
Q
What does it look like to complete a purchase of TTCs?
A
The process may at first seem daunting, but that’s where Smith Dierking comes in. We will guide you through each step to simplify and streamline your experience so you can confidently complete your purchase and realize the benefits of this new opportunity. That’s What We Do.