Revolutionizing the Clean Energy Game: Inflation Reduction Act Unlocks Lucrative Market for Transferable Federal Tax Credits

The Inflation Reduction Act was signed into law on August 16, 2022, allowing investors to purchase and sell certain federal tax credits.  Based on a report by Portland Business Journal on March 3, 2023, two major provisions of the Act relate to federal income tax credits, including direct pay provisions, which permit the refund of credits through direct payment at 100% of their value for taxable and tax-exempt entities, and tax-credit transfers, which enable credits to be monetized through transfers to a third party.  The transferable credits can be used by all taxpayers, but individual use may be restricted based on passive activity rules.

Transferable credits are a game-changer for renewable energy and other clean energy projects, providing alternatives to the costly and complex tax equity structures of traditional tax equity transactions.  However, according to a report by BDO USA on February 27, 2023, developers and owners of such projects will need to weigh the benefit of transferring credits against the cost of not being able to monetize the tax depreciation associated with the project.  Returns sought by tax equity investors versus discounts required by tax credit buyers may also factor into this decision.

Under the newly added Internal Revenue Code (IRC) Section 6418 established by the Act, eligible taxpayers can elect to transfer various tax credits to an unrelated third party, such as clean vehicle tax credits, renewable energy generation tax credits, carbon sequestration tax credits, and clean fuel tax credits. The IRS released Notice 2022-50, requesting comments on the transferability and direct pay provisions of the Act.  The transfer process is still undetermined, and purchased tax credits may only be transferred once and have a three-year carryback and 22-year carryforward.