Treasury Proposes Rules on Monetizing Energy Tax Credits

The IRS and Treasury Department proposed rules Wednesday for taxpayers looking to monetize clean energy tax credits in President Joe Biden’s tax-and-climate law.

The Inflation Reduction Act outlined alternatives for taxpayers who want to buy or sell their energy tax credits instead of using tax equity investment structures. The law allows tax-exempt and government entities to receive a refundable payment in lieu of the credit.

The new rules (RIN 1545-BQ63 and RIN 1545-BQ64) further define how the registration process works and who is eligible for the monetization options.

These methods will “dramatically speed deployment, bring many governments and nonprofits to the table for the first time, and make it easier for business at the cutting edge of clean energy to benefit from the credits,” Deputy Treasury Secretary Wally Adeyemo said in a media call Tuesday.

Direct Pay

Tax-exempt entities, states, and political subdivisions are among those that will be able to receive “direct pay” or cash as a tax refund from the government under Section 6417. Other entities will be able to sell or transfer the credit to a third party under Section 6418.

Eligible organizations must own the property or own the activity that generates the credit, according to the rules.

It’s going to be very difficult to use direct pay unless an organization has a fairly small project or a lot of money to invest in large projects, said Elizabeth Crouse, a partner at Perkins Coie.

The rules also clarify that an instrumentality of the state is eligible for direct pay. Prior to the guidance, some universities, hospitals, and school districts were uncertain if they qualified because instrumentalities were omitted from the law.

Eligible entities will be able to “engage” with for-profit partners in an arrangement that has “properly elected out of subchapter K” and still make the elective payment election, the rules say.

The direct pay rules confirm that Section 45X manufacturing production tax credits are eligible for direct pay. This “will allow a substantial volume of new American clean energy manufacturing to move forward,” Gregory Wetstone, president and CEO of the American Council on Renewable Energy, said in a statement.

The Large Public Power Council, whose 28 public power systems provide electricity to 30 million customers, “remains deeply concerned over the lack clarity regarding the domestic content rules that public power utilities must adhere to if a system elects to use direct pay to fund a new clean energy project, LPPC President John Di Stasio said in a statement.

Tax-exempt or governmental entities won’t be able to buy credits through transferability and then go to receive direct payment.

Transferability

The market to buy and sell tax credits is transforming renewable energy development financing—allowing for many companies to participate that weren’t able to before because of the high costs and complexity of tax equity structures.

Some transferability deals were penned out prior to guidance, but many in the industry expect the market to explode now that the rules are out.

The transfer agreements that were already executed prior to rules are generally aligned with the new guidance, said Heather Cooper, a partner at McDermott Will & Emery.

In a deal, the buyer of the tax credit claims the credit, but prior to the rules there was a question as to who bears the risk of recapture if a project falls out of compliance—a project an investor would not have control over.

The rules confirm that when a tax credit is bought through a transferability deal and there is a recapture event, the risk falls on the buyer of the credit.

“We’ll just have very robust indemnities within these transfer deals,” Cooper said. “What we’ve been seeing to date on the deals our clients have inked, is the expectation of a full legal indemnity.”

If there is an indirect change in ownership of project, there is no recapture on the buyer, the rules say. This clarification is huge, said Crouse, who thought companies were going to have to use blocker corporations which can be very inefficient from a tax perspective.

When sellers of the credit are claiming the bonus credits, such as domestic content or low-income community, the bonuses cannot be transferred separately, the rules say. Developers were previously looking to sell the bonuses to lower the risk of the tax credit because some of the bonuses still need more guidance.

Additionally, the guidance applies the passive loss rule to buyers, preventing individuals from using the tax credits from companies in which they are not actively involved against active income.

“It’s a pretty strict interpretation, and it will be somewhat difficult for taxpayers subject to the passive loss rules to use these credits,” Cooper said.

Following the tax-and-climate law’s passage, third party marketplaces have emerged to pair buyers and sellers together.

The rules are very favorable toward these marketplaces, said Alfred Johnson, the CEO of Crux, a company that helps facilitate tax credit transfers. Johnson previously worked at the Department of Treasury at the beginning of the Biden administration.

Registering Projects

The agencies also issued temporary rules (RIN 1545-BQ76) on the required pre-filing registration process for monetizing the credits.

Taxpayers who register projects will receive a registration number from the IRS before making the election on the tax return. The registration number will only be valid for the year it is given.

“The Treasury Department and the IRS find that good cause exists for making these temporary regulations immediately effective without notice and comment,” the rules said.

The temporary rules will expire on June 12, 2026.

The IRS also released a FAQ on the monetization rules.

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