What is “monetization”?

Monetization is the process by which property is converted into money or something else of value. In the context of the Inflation Reduction Act of 2022 (IRA), certain provisions can allow entities that are planning to construct or control clean energy facilities and projects (collectively “projects”) to monetize eligible energy tax credits.[1] 

Why does the IRA include monetization provisions?

The IRA encourages the development and funding of projects through unique provisions to encourage monetization of eligible tax credits. The Internal Revenue Code (Code) provides for two paths: (1) the so-called “direct pay” election, or (2) the “transfers/sales” election. Applicants do not get to select the monetization technique that they may prefer. Rather, certain taxpayers are eligible for the so-called “direct pay” election and others are eligible to elect “transfers/sales.” Certain credit holders can receive cash for the value of their tax credits, without regard to whether they have taxable income; such entities do not need to apply credits against federal tax liability.

It should be noted that the term, “direct pay,” is broadly used in common vernacular in connection with this IRA credit monetization method; but that the official Internal Revenue Service (IRS) terminology is “elective pay.”[2] I will be using the term, “direct pay” throughout this article.

Why does the IRA have two monetization elections, direct pay and transfers/sales?

It’s complex. Certain tax-exempt, governmental, and taxable entities can be eligible for direct pay, while other taxpayers can be eligible for transfer/sales elections.

Direct Pay

Turning to direct pay, certain tax-exempt and government entities (Applicable Entities) as well as certain taxable entities (Electing Entities) can elect to receive a direct payment from the IRS for the full value of the eligible tax credits they hold (direct pay election) under Code Section (Section) 6417.[3]

• Applicable Entities can elect 12 eligible tax credits for direct pay.
• Electing Entities can elect three eligible tax credits for direct pay.

Transfer/Sales

Turning to transfer/sales, taxpayers that are not Applicable Entities (referred to as Eligible Taxpayers) can transfer (that is, sell) their eligible credits to third parties for cash payments under Section 6418 (transferable credits).[4]

Define ‘Applicable Entities,’ ‘Electing Entities,’ and ‘Eligible Taxpayers’? 

Okay, let’s go through the three different types of eligible applicant categories:

What is an Applicable Entity?

An Applicable Entity is defined[5] as a tax-exempt organization,[6] state or local government,[7] Indian tribal government,[8] Alaska Native Corporation,[9] the Tennessee Valley Authority, or a rural electric cooperative.[10] A state or local government is defined to include an agency, instrumentality, or political subdivision based on general federal tax principles. A political subdivision includes (1) a division of a state or local government that is a municipal corporation; (2) a division of a state or local government that has been delegated the right to exercise the power to tax, eminent domain, and policy power by the state or local government; and (3) an entity that is controlled by the state or local government and that is motivated by a public purpose.

What is an Electing Entity?

A taxpayer that is not an Applicable Entity (that is, it is not a tax-exempt organization or government entity) qualifies as an Electing Entity. This means that an Electing Entity includes individuals, taxable businesses, corporations, partnerships, and trusts. Electing Entities that do not qualify as Applicable Entities (that is, they are taxable entities) are also eligible to elect direct pay with respect to three credits: Section 45Q, 45V and 45X credits.

What is an Eligible Taxpayer?

Eligible Taxpayers include for-profit corporations, partnerships, individuals, trusts, and other taxable entities. Under certain circumstances, they can sell their transferable credits to unrelated entities.

Elaborate on the property ownership requirements for direct pay?

Perhaps the easiest way to answer this question is to include the Questions and Answers from the IRS Frequently Asked Questions on Elective Pay

Q11. What type of property ownership is required for projects using elective pay? 
(updated March 5, 2024) 
A. Whether a taxpayer owns the underlying eligible credit property is determined based on the regulations for the particular applicable credit or bonus credit amount as well as federal income tax principles. Ultimately, the applicable credit must have been determined with respect to the applicable entity or electing taxpayer making the elective payment election.

With the exception of a section 45X credit, the applicable entity or electing taxpayer must both own the underlying eligible credit property and conduct the activities giving rise to the credit. In the case of a section 45X credit, ownership is not required, but you must be considered (under the section 45X regulations) the taxpayer with respect to which the section 45X credit is determined.

Q12. Can I work with other organizations and still use elective pay? 
(updated March 11, 2024)

A. You must own the property that generates the eligible credit (with the exception of a section 45X credit, see Q11). That ownership can occur through various structures. For example, you could directly own the property, could own it through a disregarded entity, or could own an undivided interest in an ownership arrangement treated as a tenancy-in-common or pursuant to a joint operating arrangement that has properly elected out of subchapter K under section 761. On March 5, 2024, the Treasury Department and IRS proposed regulations that would provide guidance on such an election out of subchapter K. […][11]

Now that we have looked at the applicant categories and property ownership requirements, let get into the details on these two types of monetization: Direct Pay and Transfer/Sales elections.

Direct Pay

How does an Applicable Entity elect direct pay?

An Applicable Entity can elect to receive a direct payment for the full value of its eligible tax credits without applying those tax credits against an actual tax liability. Before the IRA, tax credits had no value to tax-exempt entities because they did not have taxable income to mop up their value (unless they generated unrelated business taxable income).[12]

Yes, it is a confusing concept to have tax credits made available to Applicable Entities that do not remit taxes. Nevertheless, the IRA direct pay election is a very important innovation that has substantially expanded the pool of potential clean energy investors to include tax-exempt organizations and state and local government entities in the United States.

How can an Applicable Entity monetize its eligible credits?

An Applicable Entity can monetize eligible tax credits by electing to receive a direct payment (a tax refund) from the IRS in an amount equal to the value of its eligible tax credits. An Applicable Entity cannot make a direct pay election through a partnership that holds a project and in which the Applicable Entity is a partner.

Which direct pay credits are available to a (tax-exempt) Applicable Entity?

An Applicable Entity can elect direct pay for 12 credits addressed in the IRA:

Direct Pay Credits Available to Applicable Entities

• Section 30C credit 

  Alternative Fuel Vehicle Refueling Property Credit

• Section 45 credit 

  Electricity Production Tax Credit[13]

• Section 45Q credit 

  Carbon Oxide Sequestration Credit[14]

• Section 45U credit 

  Zero-Emission Nuclear Power Production Credit

• Section 45V credit 

  Clean Hydrogen Production Tax Credit[15]

• Section 45W credit 

  Qualified Commercial Vehicles Credit[16]

• Section 45X credit 

  Advanced Manufacturing Production Credit

• Section 45Y credit 

  Clean Electricity Production Credit (CEPTC)

• Section 45Z credit 

  Clean Fuel Production Credit

• Section 48 credit 

  Energy Investment Tax Credit

• Section 48C credit 

  Advanced Energy Project Credit

• Section 48E credit 

  Clean Electricity Investment Credit (CEITC)

Which direct pay credits are available to a (taxable) Electing Entity?

An Electing Entity can apply for three tax credits that are eligible for direct pay. These credits, referred to as Electing Entity Eligible Credits, are as follows:

• Section 45Q credit 

  Carbon Oxide Sequestration Credit. The first five years of the Section 45Q credit for carbon capture and sequestration equipment, beginning in any tax year after December 31, 2022, in which the taxpayer has placed in service carbon capture equipment at a qualified facility.

• Section 45V credit 

  Clean Hydrogen Production Tax Credit. The first five years of the Section 45V credit for the production of clean hydrogen.

• Section 45X credit 

  Advanced Manufacturing Production Credit. A five-year period during which the Section 45X credit for advanced manufacturing is in effect.

For Carbon Oxide Sequestration (45Q) and Clean Hydrogen Production (45V) credits, the direct pay election is limited to the first five years after a project is placed in service.[17] For Advanced Manufacturing (45X), the election can be made in any taxable year in which the entity produces eligible components.[18] Once elected, direct pay applies to the election year and each subsequent taxable year during the five-year election period.[19]

There are different rules for electing taxpayers that do allow for a one-time revocation of the elective payment election during the 5-year period the election applies.

Are these direct pay regulations finalized?

Yes. The regulations for direct pay, T.D. 9988, are finalized, and Section 6417 sets out the direct pay election rules.[20] The regulations became effective on May 10, 2024.

The regulations identify those tax credits that are eligible for direct pay, address basis reduction, denial of double benefits, and penalties for excessive payments. They explain the pre-filing registration process and set out the steps required for an applicant to make a direct pay election. Guidance is provided to both Applicable Entities and Eligible Entities to help them evaluate related project investments.

What do applicants need to know about direct pay timing considerations?

The direct pay election is available until taxable years starting before December 31, 2032 (or until the credits expire under the statutory requirements at Sections 45Y (CEPTC) and Section 48E (CEITC).[21] To qualify for the direct pay election, a project must be placed in service after 2022 and before taxable years beginning before 2033. The project must be placed in service during the same year the direct pay election is made. The direct pay election only becomes available once the credit is actually earned and claimed on a timely filed tax return. It is not available before that time.

For Sections 45Q and 45V, the Final Direct Pay Regulations apply to property placed “in service” in tax years ending on or after March 11, 2024.[22] For Section 45X credits, the regulations apply to eligible components produced in tax years ending on or after March 11, 2024.

For property placed in service or eligible components produced in tax years ending before March 11, 2024, an applicant can choose to apply the Final Direct Pay Regulations as long as their application is consistent.

How are grants, loan forgiveness, or other forms of financial support treated for tax purposes?

To calculate the amount of the available credit, an Applicable Entity that receives proceeds from loan forgiveness or nonspecific grants to develop or acquire various ITC-eligible projects exempt from federal tax must add these amounts to the property’s tax basis. Once these financial supports are combined with the tax credits, the allowable credit is reduced to the actual property cost if the combined amount exceeds that property cost.

Can a partnership qualify as an Applicable Entity?

No. A partnership is not included in the definition of an Applicable Entity, and cannot make a direct pay election for an otherwise-eligible credit—even if all of its partners are Applicable Entities.[23] It can, however, qualify as an Electing Entity for the three Electing Entity-eligible credits under Section 45V, Section 45Q and Section 45X.[24]

Can an Applicable Entity elect direct pay through a partnership or corporation?

No. An Applicable Entity cannot elect direct pay through a partnership or corporation. Rather, the partnership or corporation, itself, can elect direct pay, but only for the 45V, 45Q and 45X credits available to an Electing Entity. A partnership with one or more Applicable Entity partners is treated as an Eligible Taxpayer that can only sell those credits that are available for Eligible Taxpayers to sell.[25]

Can an Applicable Entity or an Electing Entity claim credits earned by a “disregarded entity” for tax purposes?

Yes. An Applicable Entity or an Electing Entity can elect direct pay and claim credits held by a disregarded entity that it owns.[26]

Can a joint owner elect out of the partnership tax rules so as to qualify as an Applicable Entity?

Although a taxable partnership or an S corporation cannot qualify as an Applicable Entity, certain joint owners of property can elect out of the tax partnership rules to allow Applicable Entities to elect direct pay. When some or all of the joint owners of a joint ownership arrangement are Applicable Entities, the joint ownership arrangement can elect out of the partnership rules. Proposed Treasury Regulations under Section 761 allow certain Applicable Entity joint owners to elect out of the partnership rules to retain their Applicable Entity status.[27] Four requirements must be met: 

1. The unincorporated organization is owned at least in part by an Applicable Entity.
2. The members enter into a joint operating agreement for the “applicable credit property,” defined as an electricity generating property or facility. The joint operating agreement provides that the members have the right to separately take electricity in-kind, or to dispose of their pro rata shares of electricity as well as any energy credits associated with the electricity produced, extracted, or used.
3. Under the joint operating agreement, the unincorporated organization is organized exclusively to produce electricity from the applicable credit property.
4. One or more of the unincorporated organization’s Applicable Entity members elect direct pay for the credits obtained with respect to share(s) of applicable credit property.

How can an applicant make or revoke a direct pay election?

Prior to making a direct pay election, Applicable Entities and Electing Entities must use an IRS pre-filing registration tool[28] to identify and register each facility or property for which they seek to make a direct pay election. They should register at least 120 days prior to the date they intend to file the federal tax return containing the direct pay election.

Elections must be made on an original federal tax return, which must be filed no later than the due date (including extensions) for the taxable year for which the applicable credit is determined. Elections cannot be made on an amended tax return or through an administrative adjustment request (AAR).[29] Taxpayers can, however, correct numerical errors on an amended tax return.

Electing Entities can revoke a direct pay election one time, and the revocation applies to all future taxable years.

Phase-in of Direct Pay Domestic Content Requirements

How do the domestic content requirements affect direct pay eligibility?

Carbon Oxide Sequestration, Clean Hydrogen and Advanced Manufacturing Credit-eligible projects (Sections 45Q, 45V, and 45X) that begin construction after 2024 must meet the domestic content requirement for the applicant to receive the full value of the direct pay election.[30]

If projects under Sections 45Q, 45V, or 45X do not meet the domestic content requirements, then they face phase-outs: (1) if construction begins in 2024, the reduction amount is 10 percent; (2) if construction begins in 2025, the reduction amount is 15 percent; and (3) if construction begins in 2026 or thereafter, projects will not be eligible for direct payment.

At the date of this writing, we do not have Treasury Regulations addressing application of the domestic content phase-in requirements as they relate to the direct pay election.

Are there any exceptions to the direct pay domestic content requirements?

Yes. Projects with a maximum output of less than one megawatt (MW) are statutorily excepted from the domestic content requirements. In addition, an exception is available to a project if (1) the use of U.S.-produced steel, iron, or manufactured materials would significantly increase construction costs, or (2) the materials needed by the project are not available in sufficient quantities or qualities to meet the domestic content requirements.

Treasury Regulations, when issued, are expected to address how the domestic content exceptions will be applied. Until such guidance is provided, however, taxpayers can rely on two IRS Notices: Notice 2024-9[31] and Notice 2024-41.[32] Notice 2024-9 simplified the domestic content calculations to streamline the documentation process, noting that we can expect proposed regulations in the not-too-distant future. Applicable Entities and Electing Entities must (1) attest to the fact that they qualify for the exception and (2) maintain sufficient records to demonstrate that they meet the exception.[33] Notice 2024-41 provides a New Elective Safe Harbor for the domestic content requirements to Determine Cost percentages for the Adjusted Percentage Rule[34].

Excess Benefits

What happens if an Applicable Entity receives an “Excess Benefit”?

For purposes of Section 6417, an Applicable Entity receives an “Excess Benefit” if it secures a grant, forgivable loan, or tax-exempt income to purchase, construct, reconstruct, erect, or otherwise acquire ITC-eligible property, and the sum of that Excess Benefit amount received and the applicable IRA direct pay credit exceeds the cost of the project’s property. If that is the case, the amount of the applicable credit is reduced so that the total amount of the available credit equals—but does not exceed—the cost of the related project property.[35]

Electing Direct Pay

How is a direct pay election made?

To elect direct pay, an Applicable Entity or Electing Entity should take the following steps:[36]

1. Identify the qualifying project.
2. Determine the tax year when the project is placed in service.
3. Meet all statutory eligibility requirements for the specific tax credit and any applicable bonus credits for the given tax year.
4. Obtain a registration number from the IRS for each applicable credit property.
5. Include the registration number on the tax return for the appropriate year so that the direct pay election is effective.
6. For multi-year elections, obtain new registration numbers for each year during the election period.[37]
7. File the required tax return by the due date, or any valid extensions.[38]
8. If the election on the original return includes all of the required information, numerical errors can be corrected on an amended return.[39]

When is a direct pay election payment available?

For entities that file federal tax returns, a direct pay election payment is treated as having been made on the later of the due date of the tax return or the date on which the tax return is filed with the IRS.[40] For entities that do not file returns, payment is treated as having been made on the later of the date that a return would be due, or the submission of a claim for credit or a refund is made.[41]

Can a direct pay election be made on an amended tax return?

No. A direct pay election must be made on a timely filed original tax return that is submitted no later than the tax return’s due date—including valid extensions—for the taxable year in which the credit is to be obtained. An election cannot be made on an amended tax return or through an administrative adjustment request (AAR).[42]

Are there any special requirements to qualify for the direct pay election?

Yes. To encourage energy projects to source their steel, iron, and certain Manufactured Products in the United States, three of the credits that allow direct pay also provide for a phase-in of the domestic content requirement: Sections 45Q (Carbon Oxide Sequestration), 45V (Clean Hydrogen PTC), and 45X (Advanced Manufacturing PTC).

What is the tax effect of making a direct pay election?

An Applicable Entity or an Electing Entity is treated as having made a payment against its federal income taxes for the year the credit applies, equal to the total amount of the credit. If no tax is due, or there is “any remaining federal income tax liability, the credit amount first offsets that tax liability and the rest is refunded to the Applicable Entity. If the Applicable Entity has no federal income tax liability, its refund will equal the full amount of the applicable credit.”[43] The taxpayer will receive a refund from the IRS without needing taxable income to apply the tax credit against.

Is the direct payment taxable to the recipient?

No. Because a direct payment is treated as the payment of a tax liability, the refund is not treated as taxable to the recipient of the direct payment from the government.[44]

When does an Applicable Entity or an Electing Entity receive a direct pay payment?

For entities that file federal income tax returns, direct pay election payments are treated as having been made on the later of the due date of the tax return, or the date on which the tax return is filed with the IRS.[45] For entities that do not file returns, direct pay election payments are treated as having been made on the later of the date that a return would be due, or the date the taxpayer submits a claim for credit or a refund.[46] Direct pay payments are made yearly and do not track estimated tax obligations. These payments are not made on a quarterly basis.[47]

Transfer/Sales

What is this second IRA energy credit monetization technique?

In addition to the ability to elect direct pay available to for-profit Electing Entities for Carbon Oxide Sequestration (45Q), Clean Hydrogen production (45V), and Advanced Manufacturing (45X); certain for-profit Eligible Taxpayers—including individuals, for-profit corporations, partnerships, trusts, and other taxable entities—can be eligible to sell their transferable credits to unrelated entities.

Which credits can be sold by Eligible Taxpayers?

Eligible Taxpayers can elect to sell all (or any portion) of most of the same list of IRA energy credits on which Applicable Entities can elect for Direct Pay; those are as follow:

• Section 30C credit 

  Alternative Fuel Vehicle Refueling Property Credit

• Section 45 credit 

  Electricity Production Tax Credit

• Section 45Q credit 

  Carbon Oxide Sequestration Credit

• Section 45U credit 

  Zero-Emission Nuclear Power Production Credit

• Section 45V credit 

  Clean Hydrogen Production Tax Credit

• Section 45X credit 

  Advanced Manufacturing Production Credit

• Section 45Y credit 

  Clean Electricity Production Credit (CEPTC)

• Section 45Z credit 

  Clean Fuel Production Credit

• Section 48 credit 

  Energy Investment Tax Credit

• Section 48C credit 

  Advanced Energy Project Credit

• Section 48E credit 

  Clean Electricity Investment Credit (CEITC)

 The Section 45W credit Qualified Commercial Vehicles Credit is not eligible for credit transfer.

How are transferable credits generated?

Transferable credits are generated by “eligible credit property,” which is property that an Eligible Taxpayer owns or creates. Transferable eligible credit property is specified in each of the underlying statutory provisions for the applicable IRA credits. In addition, to the extent a Section 48 ITC credit is held by an Eligible Taxpayer, the Eligible Taxpayer can transfer the credit.[48]

How does transferability work?

Referred to in the IRA as “transferability,” an Eligible Taxpayer can sell—that is, transfer—transferable credits to unrelated third parties for cash. The IRS refers to buyers of transferable credits as “Transferee Taxpayers.”[49] Beginning in an Eligible Taxpayer’s first taxable year ending after December 31, 2022, they can make a one-time election to sell (all or a portion of) its transferable credits to unrelated taxpayers for a cash payment.

How is transferable credit sale for cash defined?

Transferable credits must be sold for U.S. dollars, a check, a cashier’s check, money order, wire transfer, automated clearing house (ACH) transfer, or another bank transfer of immediately available funds.[50] Cash equivalents and other forms of payment are not permitted.

Can an Eligible Taxpayer sell transferable credits it anticipates receiving in future years?

No. Although commentators specifically asked the Treasury to allow a seller to receive an upfront payment for transferable credits it anticipates receiving in future tax years, Treasury expressed administrative and legal concerns (issues, such as whether “an excessive credit transfer has occurred, or if the eligible taxpayer has gross income if prepaid eligible credits were not transferred in a later tax year). The Final Transfer Regulations do not allow it. Accordingly, the Treasury and the IRS “adopted the paid in cash definition of the proposed regulations without change”—they did acknowledge, however, that nothing prohibits the loan of funds to an Eligible Taxpayer, “including loans secured by an eligible credit purchase and sale agreement, provided such loans are at arm’s length and treated as loans for Federal tax purposes.”[51]

Can bonus credits be separated from base credit amounts and sold separately?

No. Bonus credit amounts are treated as additions to base energy IRA credit amounts. They cannot be sold separately from those base credits. Although an Eligible Taxpayer can sell a percentage of its combined base credits and bonus credits on a project, it cannot separate its base credits from its bonus credits to sell those as separated transferable credits.[52]

What are the tax effects of a credit sale?

The tax effects of a credit sale are as follows:

• Related cash receipts are not includible in the seller’s gross income, and they are not deductible by the buyer.[53]
• If transferable credits are sold for less than their face amount, the Eligible Taxpayer does not have taxable income.[54]
• A three-year carryback rule is available for transferable credits purchased by a buyer.
• The buyer can also carry unused credit amounts forward for up to 22 years.[55]

Can an Eligible Taxpayer be prevented from selling transferable credits?

Yes. An anti-abuse rule prohibits a credit sale if a principal purpose of the transfer is to avoid tax liability.[56] The Preamble to the Final Transfer Regulations does discuss transfers that are different from the average transfer price of an eligible credit, noting that the anti-abuse rule might apply where the price paid for an eligible credit is not economically supportable and is unreasonable under the facts and circumstances.

What is the procedure to sell transferable credits?

Prior to selling transferable credits, a credit holder must review the applicable statutory provisions with respect to the applicable credits because each credit has its own statutory transfer (sale) rules. A credit holder must address all transfer requirements unique to those applicable statutory provisions. With that said, I can make some comments about selling credits:

1. Both the seller and the buyer must meet the specified eligibility requirements set out in the relevant statutory provision for the transferable credit itself, as well as in Section 6418.
2. Sales must be made in accordance with all statutory requirements.
3. Prior to making a transfer election, an Eligible Taxpayer must use an IRS pre-filing registration tool to identify and register each facility or property that generates a transferable credit for which an election will be made. All Eligible Taxpayers should register at least 120 days prior to the date they intend to file the federal tax return containing the transfer election.
4. An Eligible Taxpayer must register with the IRS and file an “election to transfer” before it can transfer and report those transferable credits on its tax return.
5. Once registration is complete, an Eligible Taxpayer receives a unique registration number for each transferable credit that it intends to sell.
6. The unique registration number must be included on the Eligible Taxpayer’s completed tax return.
7. Registration numbers are valid only for the taxable year requested, although they can be renewed.
8. Transferable credits cannot be pooled together.
9. The transferable credit seller and buyer must negotiate the terms of a “transfer election statement” and the seller must execute it. The IRS has not provided taxpayers with a standardized tax form for the purposes of this agreement.
10. Elections must be made on an Eligible Taxpayer’s original federal tax return, which must be filed no later than the due date (including extensions) for the taxable year for which the transferable credit is determined.[57]
11. The transfer election must be made no later than the due date of the tax return for the year in which the transferable credit is claimed.
12. The sale must be made in cash during that same taxable year.
13. The amount received by an Eligible Taxpayer is not included in income.
14. The credit buyer cannot deduct from its income the transferable credit purchase payment.
15. Without a proper IRS registration number, a sale is invalid.

An Eligible Taxpayer can sell transferable credits to as many buyers as are available to buy them, provided payments received do not exceed the total value of the transferred credits.

For ITC-based type credits under Sections 30C, 48, and 48C, transfer elections are made on a property-by-property basis.[58] For the ITC-based credit at Section 48E, transfer elections are made on a facility-by-facility basis.[59]

For PTC-based credits under Sections 45 (Renewable Electricity Production Credit), 45U (Zero-Emission Nuclear Power Production Credit), 45V (Clean Hydrogen Production Tax Credit), 45X (Advanced Manufacturing Production Credit), 45Y (Clean Electricity Production Credit or CEPTC), and 45Z (Clean Fuel Production Credit) transfer elections are made on a facility-by-facility basis. Elections to transfer Section 45Q (Carbon Oxide Sequestration Credit) credits are based on the unit of carbon capture equipment.

How is a transfer election made on a tax return?

Prior to making a transfer election, a taxpayer must use an IRS pre-filing registration tool[60] to identify and register each facility or property that generates the transferable credit for which an election will be made.

Electing Taxpayers should register at least 120 days prior to the date they intend to file the federal tax return containing the transfer election.

An Electing Taxpayer must file the election to transfer on its original tax return—or a superseding return if that return is filed before the due date of the original return—including valid extensions.

Can a transfer election be made on an amended tax return?

No. The election cannot be made on an amended tax return or an administrative adjustment request (AAR). Administrative relief is not available if an election was not timely made for the taxable year for which the credit is determined.[61] After making a timely and complete transfer election, an Eligible Taxpayer can file an amended return or an AAR, for a numerical error but not for other errors. The rules on revocation differ for a direct pay election and a transfer election: Once a transfer election is made, the taxpayer cannot revoke it.

Can a Transferee Taxpayer (buyer) make additional transfer elections?

No. Under Section 6418, “No election may be made under subsection (a) by a transferee taxpayer with respect to any portion of an eligible credit which has been previously transferred to such taxpayer pursuant to this section.”[62]

Does a credit transfer affect estimated payments?

The Preamble to the Final Transfer Regulations says that a Transferee Taxpayer steps into the shoes of the Eligible Taxpayer (seller), and can thus take into account the transferable credit for purposes of determining its quarterly estimated liability.

How does a partnership or an S corporation elect to sell transferable credits?

A partnership or an S corporation that directly holds transferable credits can make a transfer election with respect to them. Partners/shareholders, however, cannot make the election for the entity itself.[63] If the subject entity sells credits, the sale generates tax-exempt income treated as income from an investment, not from a trade or business. Such income is not treated as passive income.[64] Related distributive shares is treated as tax-exempt income that is allocated in the same proportionate amounts as would have been received if the transferable credit(s) had not been sold.

What happens if project property is disposed of before the close of the transferable credit recapture period?

If “applicable investment credit property” is disposed of before the close of the recapture period[65]—or it ceases to be ITC property—certain notifications are required. An Eligible Taxpayer must notify the buyer of the recapture event on a prescribed form and in the manner required by the Treasury or the IRS. Recapture is required if the applicable ITC property is disposed of (or it ceases to be ITC property) before the close of the recapture period.[66] If the project becomes ineligible for the credit after the transfer, the buyer becomes responsible for any tax on the recaptured tax credits. Although the buyer is responsible for the recapture, nothing prohibits an Eligible Taxpayer from indemnifying their buyer against a possible recapture event. Disposition of a partnership (or an S corporation) interest does not trigger recapture[67] so the Eligible Taxpayer need not notify its buyer of such an event.

Credit Buyers (Transferee Taxpayers)

Do the “passive activity rules” apply to transferred credits?

Yes. If an individual, estate, trust, closely held C corporation, or personal service corporation[68] transfers credits, it has either a “passive activity loss” or a “passive activity credit” for a taxable year. That passive loss or credit is disallowed and “treated as a deduction” or carried forward into the next taxable year.[69] Section 469 addresses passive activity losses and credit limitations. “Passive activity loss” is defined as the amount that aggregate losses from all passive activities for the taxable year exceed the aggregate income from all passive activities for that year.[70] The term “passive activity credit” is defined as the amount (if any) by which “(A) the sum of the credits from all passive activities allowed for the taxable year under (i) subpart D of part IV of subchapter A, or (ii) subpart B (other than Section 27) of such part IV, exceeds (B) the regular tax liability of the taxpayer for the taxable year allocable to all passive activities.”[71]

Why do passive activity rules apply to credit transfers?

The passive activity rules apply because the transferable credits are treated as having been earned in a trade or business. Once transferred, however, the credit buyer is subject to the Section 469 passive activity rules. The Preamble to the Final Transfer Regulations noted that nothing in the Section 6418 credit transfer rules suggested that the passive activity rules should be disregarded. When Congress “desired to alter the application of certain rules, they provided as such.”[72] Congress did not provide a carveout for Section 469 in Section 6418, so the Treasury took this to mean a carveout was not intended.

As the Treasury also noted, “a credit is subject to the passive credit rules if the credit arises in the conduct of a trade or business in which the taxpayer does not materially participate in the year to which it is attributable, and the credit is a general business credit under Section 38. All of the eligible credits listed in Section 6418(d) arise in the conduct of a trade or business and are general business credits under Section 38.” The Treasury noted further that “Section 469 applies to the use of such eligible credits unless Congress provides otherwise, and commenters did not point to strong statutory or other evidence that Congress intended a different result. Moreover, any differences in the application of the passive credit rules among taxpayers is a result of Section 469(a) and not the result of Section 6418 or the proposed regulations.”[73]

The Treasury states “it is not inconsistent to apply Section 469 to a transferee taxpayer that is treated as the taxpayer for purposes of the Code with respect to a transferred credit.”[74] It makes sense that transferred credits will retain the same attributes and limitations as those credits earned and used by Eligible Taxpayers.[75] The Final Transfer Regulations confirm “that if an individual transferee taxpayer does not materially participate (within the meaning of Sections 1.469–5 and 1.469–5T) in the activity that generates a specified credit portion, a transferred specified credit portion will be treated to the transferee taxpayer as arising in connection with a passive activity.”[76]

When does a credit buyer tax account for a purchased credit?

A buyer takes a transferred credit into account in its first taxable year that ends after the end of the taxable year in which the Eligible Taxpayer sold the credit. The Preamble to the Final Transfer Regulations provides an example of how a transferred credit is taken into account. Suppose that an Eligible Taxpayer has a June 30th Year End, and the buyer has a December 31st Year End. Assume further that the credit is transferred to the buyer in November 2023. In this situation, the buyer will take the transferred credit into account in its first taxable year ending after June 30, 2024.

Excess Transfer Penalties

What happens if an Eligible Taxpayer transfers credits in excess of the amount of actual available credits?

The estimated amount of a tax credit sold by an Eligible Taxpayer must be a reasonable amount that is based on reasonable expectations and estimates. But the buyer—not the seller—is responsible for any additional tax and penalties if the transferred credit amount exceeds the allowable credit amount. The buyer is responsible for any additional taxes and penalties . . .and without regard to whether that buyer is tax-exempt.[77] A 20-percent penalty is assessed on an “excessive credit transfer.”

What are some of the business and tax risks that a transfer credit buyer might face?

As I mentioned above, the buyer is responsible for additional taxes and penalties if the transferred amount exceeds the transferable credit. An excessive credit amount could result from any of the following situations:

1. PWAP requirements were not met during the five-year period after the project was placed in service so there is a recapture.
2. Domestic Content rules were not met, so the credits were not eligible for the 10 percent Domestic Content Bonus Credit.
3. If the tax basis of the qualifying property is lower than the Eligible Taxpayer had calculated as the actual value of the credit amount.
4. The Eligible Taxpayer did not comply with statutorily defined transfer procedures—so the credit transfer did not take place.
5. A recapture event occurs within the first five years after the project is placed in service. Recapture events include, for example, sales of the project, a casualty loss, or an event that prevents normal operations for an extended period of time.
6. A project becomes tax-exempt property during the five years after a project is placed in service.[78]

Can an excessive transfer penalty be avoided?

Yes. The 20 percent excessive transfer penalty can be avoided if the buyer can demonstrate—to the satisfaction of the government—that the purchase amount was reasonable. The taxpayer can demonstrate “reasonableness” based on the facts and circumstances of the purchase, given the buyer’s detailed review of the transaction.[79] As the Treasury noted in the Preamble to the Final Transfer Regulations, the most important factor demonstrating reasonable cause is “the extent of the transferee taxpayer’s efforts to determine that the amount of specified credit portion transferred by the eligible taxpayer to the transferee taxpayer is not more than the amount of the eligible credit determined with respect to the eligible credit property for the taxable year in which the eligible credit was determined and has not been transferred to any other taxpayer.”

What might qualify as reasonable cause?

Reasonable cause to avoid the excessive transfer penalty might include the following:

1. Review of the Eligible Taxpayer's records with respect to the determination of the transferable credit, including documentation evidencing eligibility for bonus credit amounts.
2. Reasonable reliance on third-party expert reports.
3. Reasonable reliance on representations from the Eligible Taxpayer that the total specified credit portion transferred (including portions transferred to other transferee taxpayers in a case in which an Eligible Taxpayer makes multiple transfer elections with respect to a single transferable credit property) does not exceed the total eligible credit determined with respect to the eligible credit property for the taxable year; and
4. Review of audited financial statements provided to the Securities and Exchange Commission (and underlying information), if applicable.[80]

“Chaining”

Can a credit buyer subsequently elect direct pay to cash out purchased credits?

No. A credit purchaser cannot subsequently elect direct pay. The Final Direct Pay Regulations prohibit a buyer (that also meets the definition of an Applicable Entity) from making a direct pay election after buying a credit. Referred to as “chaining,” chaining is not specifically prohibited in Sections 6417 and 6418 but the Treasury Regulations do prohibit it. Chaining would involve the sale of tax credits by an Eligible Taxpayer to an Applicable Entity or an Electing Entity that would then, in turn, seek to elect a direct payment from the government.

In Notice 2024-27[81] the IRS requested comments on whether a buyer of a transferred credit that qualifies as an Applicable Entity should be allowed to elect direct pay. The IRS said that in reading Sections 6417 and 6418 together, these two provisions are “most straight forwardly understood as creating two separate, mutually exclusive regimes regarding credit monetization.” The IRS went on to say, however, that, “while the Treasury Department and IRS acknowledged in the preamble to the Section 6417 Final Regulations that no specific language in Sections 6417 or 6418 directly prohibits chaining, not permitting chaining allows for more straightforward application of the statute as a whole. The Treasury Department and IRS also remain concerned about the administrability of chaining and potential for fraud and abuse. Thus, the section 6417 Final Regulations do not permit chaining.”[82]

Are there any circumstances in which “chaining” might be allowed?

Perhaps. Chaining might ultimately be allowed in certain circumstances. As was pointed out by Kat Lucero in a Law360 article, “Treasury kept some hope alive in the final rules that it may allow chaining in certain circumstances, such as when a government entity needs to set up a separate business entity to capitalize on the credits because it is limited in its business activities. [...] [T]he Large Public Power Council, an advocacy group for 28 utilities across the U.S., said chaining should be allowed in the case of a public utility that has a long-term power purchase agreement with a third-party developer that installs, owns and operates an energy system on a property owned by the utility or another government entity.”[83]

Lucero went on to note, "Chaining should be allowed when the utility is involved in the project's development, conducts ‘reasonable and customary diligence’ on the development's eligibility for the credits and pays an arm's-length price for the credits, the council said in a comment letter in August.” There have been a lot of discussions over chaining so it is possible that the government might change its position. As the preamble to the Final Direct Pay Regulations noted, the Treasury will continue to consider whether chaining might be appropriate in certain limited circumstances. […] As Treasury and IRS looked through the comments addressing chaining, they realized “there really were a lot of things that came into play,” said James Holmes of the IRS Office of Associate Chief Counsel for pass-throughs and special industries”[84] speaking at the May 2024 American Bar Association Tax Section Meeting in Washington, D.C.

Are buyers in the marketplace interested in buying energy tax credits?

Yes. An active market in transferable tax credits has been developing alongside the development of renewable projects that have been encouraged and supported by the IRA’s financial incentives. Obviously, buyers are negotiating to buy credits below their face amount. In other words, credits are being sold at a discount.

State and Local Taxation

Monetization can be tax-free for federal income tax purposes but what about state and local taxation?

Although monetization techniques provide a tax advantage for federal income tax purposes, taxpayers must still consider the State and local taxation implications and consequences. Because States incorporate the Internal Revenue Code into their income tax laws in different ways, taxpayers must consider the relevant State tax treatments of these IRA credit monetization transactions.

What are the State approaches to incorporating federal tax codes?

Briefly, they are Date-based, As-Amended, Annual Batch Processed or Select Codes. Some States incorporate the Code as of a specific date; others incorporate the Code on an “as amended” basis; still others only adopt selected Code provisions.

If a State were to apply the Code as of a specific date, the State legislature would need to enact legislation to apply any Code provisions that were enacted after the specified date of that State’s enabling legislation. Some States address Code updates on an ongoing basis by annually passing legislation to confirm the State laws to the newest version of the Code. If a State incorporates the Code “as amended” in its enabling legislation, the monetization provisions would apply in that State without the need for further legislative actions. Other States update their laws on a sporadic or occasional basis.

In other words, some States might tax monetization transactions that are not taxable for federal tax purposes. For example, although direct payments are not taxable under Section 6417, in a state that has not incorporated Section 6417 into its laws, monetization payments might be taxable under that state’s state law. This might be the tax result, even though the buyer of an eligible tax credit under Section 6418 receives a capital asset for federal tax purposes with a tax basis equal to the amount the buyer paid for the tax credit. Under State law, however, when the buyer uses the credits, the buyer might have taxable gain on the difference between the tax liability offset by the credit and the amount the buyer paid for the credit. Therefore, it is critical for the taxpayer to track both its federal and state basis in its capital assets.

The firm extends gratitude to Nicholas C. Mowbray for his comments and exceptional assistance in the preparation of this article.

[1] The Inflation Reduction Act of 2022, Pub. L. No. 117-169, 136 Stat. 1818 (2022) (IRA), August 16, 2022. 
An additional energy credit was created in the CHIPS and Science Act of 2022, Pub. Law 117-167, 136 Stat. 1366, August 9, 2022.

[2] The IRS calls direct pay, “elective pay.” On their webpage, “Elective pay and transferability,” available at https://www.irs.gov/credits-deductions/elective-pay-and-transferability IRS specifically notes “elective pay is sometimes also known as ‘direct pay,’ which shouldn't be confused with the IRS payment method” (for remitting taxes to the federal government—see also, “Direct Pay with Bank Account” available at https://www.irs.gov/payments/direct-pay). While this may seem to be an obvious point, it’s one that IRS has seen a need to address—so I need to be clear on the language. 

[3] § 6417.

[4] § 6418.

[5] § 6417(d)(1)(A)

[6] Described in §§ 501 through 530. Not-for-profit entities under state law that do not have federal tax-exempt status cannot make a direct pay election.

[7] Proposed § 1.6417–1(c)(7) would provide that applicable entities include any agency or instrumentality of any State, the District of Columbia, Indian tribal government, U.S. territory, or political subdivision thereof.

[8] As defined in § 30D(g)(9). To provide Indian tribal governments parity with state governments, proposed § 1.6417-1(c)(3) would include subdivisions of Indian tribal governments in this definition.

[9] As defined in 43 U.S.C. 1602(m), § 3.

[10] § 6417(d)(1).

[11] “Elective pay and transferability frequently asked questions: Elective pay,” IRS, Q11 and Q12, available at https://www.irs.gov/credits-deductions/elective-pay-and-transferability-frequently-asked-questions-elective-pay#q11 .

[12] Credits could be retroactively applied to the prior taxable year and carried forward to future taxable years.

[13] There are placed in service date restrictions for §§ 45, 45Q, and 45V. “Elective pay and transferability frequently asked questions: Elective pay,” IRS, Q13 (updated March 5, 2024) available at https://www.irs.gov/credits-deductions/elective-pay-and-transferability-frequently-asked-questions-elective-pay#q13

[14] Ibid.

[15] Ibid.

[16] Elective pay for the Commercial Clean Vehicle Credit (45W) is only available to an organization exempt from the tax imposed by subtitle A by reason of §§ 501 through 530 of the Code; a State, the District of Columbia, a political subdivision thereof, or any agency or instrumentality of any of the foregoing; a U.S. territory, a political subdivision thereof, or any agency or instrumentality of any of the foregoing; or an Indian tribal government, a subdivision thereof, or any agency or instrumentality of any of the foregoing. There are additional limitations: see Q11 and Q12 at https://www.irs.gov/credits-deductions/elective-pay-and-transferability-frequently-asked-questions-elective-pay#q11 and Q12 https://www.irs.gov/credits-deductions/elective-pay-and-transferability-frequently-asked-questions-elective-pay#q11.

[17] §§ 6417(d)(1)(B) and (C).

[18] § 6417(d)(1)(D).

[19] “Elective pay and transferability frequently asked questions: Elective pay,” IRS, Q30 (updated March 5, 2024) available at https://www.irs.gov/credits-deductions/elective-pay-and-transferability-frequently-asked-questions-elective-pay.

[20]  T.D. 9988, available at https://www.federalregister.gov/documents/2024/03/11/2024-04604/elective-payment-of-applicable-credits-elective-payment-of-advanced-manufacturing-investment-credit effective March 11, 2024, updated April 16, 2024, and effective May 10, 2024 under §§ 48D and 6417. For dates of applicability, see §§ 1.6417-1(q), 1.6417-2(f), 1.6417-3(f), 1.6417-4(f), 1.6417-5(d), 1.6417-6(e), 301.6241-1(b)(1), and 301.6241-7(k)(3).

[21] For a discussion of §§ 45Y and 48E, see Part II of this series: Production Tax Credits and Investment Tax Credits: The Old and The New.

[22] Notwithstanding, a direct pay election is available for a taxpayer’s first taxable year starting after December 31, 2022. Final Direct Pay Regulations did not change the effective date.

[23] §§ 50(b)(3) and 50(b)(4)(A)(i) might limit the amount of the eligible ITCs determined with respect to any tax-exempt or government entity partner.

[24] §§ 6417(d)(1)(B), (C), and (D).

[25] § 50(b)(3) and (4) might limit the amount of the eligible ITCs determined with respect to any tax-exempt or government entity partner.

[26] Final Direct Pay Regulations § 1.6417-4(a).

[27] REG-101552-24, Supplementary Information, available at https://public-inspection.federalregister.gov/2024-04606.pdf. Public-private partnerships are not Applicable Entities because they are treated as partnerships for tax purposes.

[28] “Inflation Reduction Act (IRA) and CHIPS Act of 2022 (CHIPS) Pre-Filing Registration Tool,” IRS Publication 5884 contains guidance regarding the pre-filing registration tool, and is available at https://www.irs.gov/pub/irs-pdf/p5884.pdf.

[29] §§ 6227(c) and (d). An AAR is an amended tax return for partnerships that are subject to the Bipartisan Budget Act (BBA) centralized partnership audit rules.

[30] For a discussion, see also Part V: Domestic Content Bonus Credits of this series.

[31] Dec. 28, 2023. Statutory Exceptions to Phaseout Reducing Elective Payment Amounts for Applicable Entities if Domestic Content Requirements are Not Satisfied.

[32] May 24, 2024. Domestic Content Bonus Credit Amounts under the Inflation Reduction Act of 2022: Expansion of Applicable Projects for Safe Harbor in Notice 2023-38 and New Elective Safe Harbor to Determine Cost Percentages for Adjusted Percentage Rule.

[33] Notice 2024-9 provides transitional procedures for property eligible for direct pay that started construction before January 1, 2025, to claim the statutory exception from domestic content requirements.

[34] See also Part V Domestic Content Bonus Credits in this series.

[35] “Elective pay and transferability frequently asked questions: Elective pay,” IRS, Additional elective payment election rules, Q41 (updated March 5, 2024) available at https://www.irs.gov/credits-deductions/elective-pay-and-transferability-frequently-asked-questions-elective-pay.

[36] “Elective pay and transferability frequently asked questions: Elective pay,” IRS, How do I make an elective payment election and receive an elective payment? Q18 (updated March 5, 2024) available at https://www.irs.gov/credits-deductions/elective-pay-and-transferability-frequently-asked-questions-elective-pay.

[37] “Elective pay and transferability frequently asked questions: Elective pay,” IRS, What is the pre-filing registration process? Q37 (updated March 5, 2024) available at https://www.irs.gov/credits-deductions/elective-pay-and-transferability-frequently-asked-questions-elective-pay. “For example, to make an elective payment election for the Renewable Electricity Production Credit with respect to a particular energy property over the course of the 10 years provided in the statute requires annually completing the pre-filing registration process to renew the registration number with respect to that property.

[38] “Elective pay and transferability frequently asked questions: Elective pay,” IRS, How do I make an elective payment election and receive an elective payment? Q18. (updated March 5, 2024) available at https://www.irs.gov/credits-deductions/elective-pay-and-transferability-frequently-asked-questions-elective-pay.

[39] A taxpayer cannot correct an item that had been left blank on the original return.

[40] Treas. Reg. § 1.6417-1(h)(1).

[41] Treas. Reg. § 1.6417-1(h)(2).

[42] §§ 6227(c) and (d); Treas. Reg. §§ 301.6227-1(c) and (d).

[43] “Elective pay and transferability frequently asked questions: Elective pay,” IRS, How do I make an elective payment election and receive an elective payment? Q24 (added June 14, 2023) available at https://www.irs.gov/credits-deductions/elective-pay-and-transferability-frequently-asked-questions-elective-pay.

[44] § 6402.

[45] Treas. Reg. § 1.6417-1(b)(1).

[46] Treas. Reg. § 1.6417-1(b)(2).

[47] Treas. Reg. § 1.6417-2(d).

[48] Preamble to 89 FR 34770, “Transfer of Certain Credits,” April 25, 2024, available at https://www.federalregister.gov/documents/2024/04/30/2024-08926/transfer-of-certain-credits.

[49] § 6418(a). Transferee Taxpayers are not related to Eligible Taxpayers within the meaning of § 267(b) or 707(b)(1).

[50] § 6418(b)(1).

[51] Preamble, Final Transfer Regulations. 89 FR 34770.

[52] Preamble, Final Transfer Regulations. 89 FR 34770.

[53] § 6418(b)(2) and (3).

[54] Treas. Reg. § 1.6418-2(f)(2).

[55] “Tax Provisions in the Inflation Reduction Act of 2022 (H.R. 5376),” Congressional Research Service, p. 17, updated August 10, 2022.

[56] 89 FR 34770, § 1.6418-2(e)(4)(ii).

[57] Elections cannot be made on an amended return or through an AAR, although taxpayers can correct numerical errors on an amended return.

[58] For a discussion of the ITC-type credits, see Part II of this series: Production Tax Credits and Investment Tax Credits: The Old and The New.

[59] For a discussion of the PTC-type credits, see Part II of this series: Production Tax Credits and Investment Tax Credits: The Old and The New.

[60] “Inflation Reduction Act (IRA) and CHIPS Act of 2022 (CHIPS) Pre-Filing Registration Tool,” IRS Publication 5884 contains guidance regarding the pre-filing registration tool, and is available at https://www.irs.gov/pub/irs-pdf/p5884.pdf.

[61] § 6418(e)(1).

[62] § 6418(e)(2).

[63] Code § 6418(c).

[64] Tax exempt for purposes of Code §§ 705 and 1366.

[65] Defined in Code § 50(a)(1)

[66] § 6418(g)(3)(B).

[67] § 1.6418-3(a)(6). 

[68] § 469(a)(2).

[69] § 469(b)

[70] § 469(d)(1).

[71] § 469(d)(2).

[72] Preamble 89 FR 34770, p.34783.

[73] Ibid.

[74] Ibid.

[75] Preamble 89 FR 34770, p.34784.

[76] Preamble 89 FR 34770, p.34785.

[77] § 6418(g)(2). Buyers can be taxable or tax-exempt entities.

[78] § 50(b)(3).

[79] 2024-12 IRB 715.

[80] Preamble, 89 FR 34770, p 34793.

[81] § 6418(g)(2).

[82] Notice 2024-27.

[83] Kat Lucero, “Treasury’s Energy Tax Credit Regulations Leave Room for ‘Chaining,’” Law360 Tax Authority, May 9, 2024, https://www.law360.com/tax-authority/articles/1831788/print?section=tax-authority/federal

[84] Ibid.

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Read Part I, Part II, Part III, Part IV, Part V, Part VI, and Part VII here.