Prepared by Jeff Fitzgerald and Brandon Hill
The Inflation Reduction Act (IRA) contains several tax-related provisions, including clean-energy tax incentives in the form of tax credits.
Dependent upon the relevant tax status, certain entities can either receive direct payment, and/or transfer (sell) all or a specified portion of an eligible credit to an unrelated taxpayer in exchange for cash. The election to transfer or sell a clean-energy credit is available for tax years beginning after December 31, 2022.
Buying or selling the tax credits can bring many tax benefits, but the rules are complex. Learn what you need to know to take advantage.
The early bird gets the worm (and tax savings). The market for 2023 tax year credits was compressed given the IRS tax credit registration portal went live in December. Due to limited supply and increased demand, the prices for 2023 credits rose accordingly.
Companies willing to transact early for 2024 credits may see favorable pricing and generate significant estimated tax payment savings and cash flow.
The final guidance was largely consistent with the proposed regulations previously issued. No exemption was provided to taxpayers subject to the passive activity loss rules (i.e., individuals, trusts, and certain closely held corporations), thus those limitations still need to be analyzed for any taxpayers contemplating a credit purchase.
While there are still some secondary issues to be addressed, such as the tax treatment of transaction costs and the potential for “chaining” (i.e., allowing applicable entities, such as nonprofits and state and local governments, to purchase credits from for-profit entities and then claim direct pay), the final regulations provide no major surprises or impediments to the burgeoning tax credit transferability market.
Eligible entities transferring or selling eligible credits have several financial statement accounting considerations. Under the new tax laws, certain credits contain direct-pay options or transferability (i.e., sale) options, or in certain cases, both.
Direct-pay credits
Direct-pay options allow an applicable entity to elect to treat applicable credits as a direct payment against income tax liability and obtain a refund for excess amounts, if any.
If an entity can elect to treat a tax credit as a direct payment of income tax and receive a refund, these credits represent refundable credits and should be accounted for outside of the scope of ASC 740. That is, direct-pay credits should be accounted for as government assistance received by business entities.
Due to the lack of authoritative guidance under current United States Generally Accepted Accounting Principles (US GAAP), a question arises as to how applicable entities should account for applicable credits not within the scope of ASC 740.
In practice, and until authoritative guidance is issued by the Financial Accounting Standards Board (FASB), three existing accounting frameworks are used:
Each of the frameworks includes differences in timing of recognition, measurement, and presentation within financial statements.
Consult your financial statement accounting advisors and financial statement auditors on which accounting framework should be used and adhered to as an elected and stated accounting policy.
Transferable credits
Like direct-pay credits, US GAAP does not directly address how to account for credits a financial statement reporting entity may use to reduce an income tax payment or sell for cash to another entity.
On the one hand, like direct-pay credits, entities can monetize transferable credits outside of the income tax system, which may seem akin to a refundable credit and therefore be accounted for outside the scope of ASC 740.
On the other hand, once the credit is sold or transferred, the acquiring entity can only use the credit to offset its income tax liability and it then may be more appropriate to account for transferable credits within the scope of ASC 740.
Based on feedback received from FASB staff on an inquiry for this issue, it’s acceptable for an entity to account for transferable credits in a manner like direct-pay credits (i.e., not within the scope of ASC 740) or as income tax credits within the scope of ASC 740. The election for either approach should be stated as an accounting policy and applied consistently.
If an entity elects to account for transferable credits in accordance with ASC 740, additional accounting policy elections are required. If the tax credit doesn’t fully reduce current income taxes payable but is instead carried forward (i.e., not refundable), a deferred tax asset (DTA) should be recognized for the carry forward amount within the entity’s income tax provision calculation and assessed for realizability.
With the ability for entities to transfer or sell certain eligible credits, entities are required to make additional accounting policy elections whether the gain or loss on sale is recognized as a component of:
If the entity elects to recognize the gain or loss as a component of income tax expense, the next accounting policy election is whether the expected proceeds are to be considered in the DTA realizability (i.e., valuation allowance) assessment.
If the entity elects to consider the expected proceeds within the realizability assessment, a DTA should be recognized equal to the expected proceeds from the sale. Subsequent changes to the expected proceeds versus the actual proceeds should also be reflected within income tax expense or benefit.
This could result in, for example, a reduction in a valuation allowance upon determination to sell an eligible credit, or recognition of DTAs that otherwise would have been fully valued (via a valuation allowance against the DTA) as a deferred income tax benefit.
If the entity elects to not consider the expected proceeds within the realizability assessment, the resulting gain or loss is reflected within the income tax provision upon sale.
Absent the above accounting policy elections, assessment for realizability of DTAs is based on the four available sources of taxable income outlined in ASC 740-10-30-18, which would not include the expected proceeds upon sale in the realizability assessment of the related DTA.
Purchases of transferable credits
Entities purchasing eligible credits from another entity must use the credit against its own income taxes payable. As a result, the purchasing entity should follow the guidance of ASC 740-10-25-52 and the related examples contained within the implementation guidance of ASC 740-10-55-199 (Case F). That is, the difference between the notional amount of the credit purchased (i.e., the amount that can offset the purchaser’s income taxes payable) and the amount paid for the credit is recognized as deferred income via a deferred credit. As the purchaser uses the credit, the deferred credit is recognized as an income tax benefit.
Deferred credits should be presented in the financial statements on the balance sheet separate and apart from deferred income taxes and income taxes payable or receivable.
Consider this example:
Buyer B acquires eligible credits notionally worth $10 million from Seller A for $9 million cash. Buyer B would record the following entries within its financial statements:
Sec. 6418(a) of the IRC treats the buyer as the taxpayer that determined the credit, meaning the buyer is responsible to support the acquired eligible credit. If the buyer cannot provide sufficient support under examination by the taxing authority, or the eligible credit is determined to be ineligible and subject to recapture provisions, the buyer is the primary obligor to the taxing authority for any ineligible amount.
As a result, purchasers of transferable credits may seek to obtain tax insurance (typically paid for by the sellers) from third parties to protect themselves against recapture provisions contained within the IRC, and/or other risks surrounding the eligible basis for credit amounts.
In addition to, or in lieu of third-party insurance, buyers of eligible credits may also enter indemnification arrangements with the selling/transferring entity.
Purchased insurance coverage from a third party to mitigate tax exposure should consider the guidance in FASB Topic ASC 720-20, Insurance Costs. Income tax indemnifications are contractual arrangements between two parties where one party will reimburse the other for income taxes paid to a taxing authority related to tax positions arising prior to a transaction.
Notably, the accounting for indemnification arrangements is dissimilar to the accounting for purchased insurance coverage from a third party under ASC 720-20, Insurance Costs.
Uncertainty and purchasing transferable credits
In the event a purchased credit may be subject to the recapture provisions of the regulations, or there is a question as to the more-likely-than-not amount of the credit to be recognized within the financial statements, the purchaser may need to assess whether an uncertain tax position has arisen, and potentially consider de-recognition for all or a portion of eligible credits via an unrecognized tax benefit (UTB) in accordance with ASC 740-10.
Uncertainty within uncertainty
A UTB may impact the amount of tax benefit recognized, on a net basis, for credits acquired. That is, the amount of any estimated exposure could offset some or all the deferred credit or acquired income tax benefit. The financial statement accounting for the interplay between UTBs and deferred credits is not covered within any current accounting guidance.
Therefore, there is a question as to how the interaction between UTBs and deferred credits is appropriately accounted for in these situations, if applicable.
Financial statement presentation
The difference in accounting treatment for uncertain tax positions and insurance coverage or indemnification agreements may result in a gross up within the income statement and balance sheet presentation. That is, de-recognition of any related eligible credits via a UTB should accounted for and presented through income tax expense in accordance with ASC 740-10, and recognition of any related receivable should be accounted for and presented within pre-tax income.
A right to offset these amounts within the financial statements doesn’t exist. The UTB liability, if any, is payable to the taxing authority, while the receivable, if any, is due from a separate third party. Any indemnity receivable recognized should be assessed for collectability (i.e., the seller’s ability to pay the indemnity should be considered, which may create additional complexities).
Seller considerations
Since, in accordance with IRC Sec. 6418(a), the indemnifying party (i.e., the seller) is not the primary obligor to the taxing authority, sellers should account for the tax risk in accordance with FASB Topic ASC 460, Guarantees.
Generally, this subtopic requires the use of fair value based on the guidance within FASB Topic ASC 820, Fair Value Measurements and Disclosures, which is outside the scope of this discussion. Selling entities entering indemnification agreements with buyers should consult their financial statement advisors and attest firms.
Guidance from the Organization for Economic Coordination & Development (OECD) issued in July of 2023 indicates eligible credits will receive favorable treatment under the global minimum tax structure. Specifically, the sale of transferable tax credits by multinational entities (MNEs) will be treated as generating additional income rather than as a tax reduction for the seller.
For MNEs purchasing transferable tax credits, only the difference between the notional value of the tax credit and the purchase price will be deemed to reduce a buyer's tax burden for purposes when calculating the effective tax rate (ETR). That is, by treating only the net discount as a reduction in taxes (versus the notional value of the tax credit), the buyer is deemed having paid U.S. taxes equal to the purchase price of the tax credit.
The preamble to the proposed regulations says a transferee taxpayer could consider a specified credit portion it has purchased, or intends to purchase, for estimated tax payment purposes.
The final regulations confirm the phrase “intends to purchase” applies to situations where the taxpayer plans to complete a transaction satisfying the transfer election requirements (such that the taxpayer would qualify as transferee taxpayer with respect to a credit) but has not yet done so.
Thus, not all the transfer election requirements have to be met for the transferee taxpayer to take an anticipated credit into account for estimated tax payment calculations. However, the taxpayer remains liable for any applicable interest and penalties if an underpayment of estimated tax occurs because the credit is not purchased as planned.
The ability to use purchased tax credits to offset estimated tax payments is an efficient tax planning tool for many corporate taxpayers. By timing a potential tax credit purchase on or about a quarterly estimated tax payment due date, taxpayers can generate immediate cash tax savings without needing to claim a refund from the IRS.
Further, the guidance potentially allows for situations where a specific credit portion may be considered for estimated tax payment calculations without remitting payment to either the IRS or the credit transferor for certain time periods.
For more information on transferable credits, contact Brandon Hill at brandon.m.hill@claconnect.com or 816-671-8914 or Jeff Fitzgerald at jeff.fitzgerald@CLAconnect.com or 714-795-5436.
The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CLA) to the reader. For more information, visit CLAconnect.com.
CLA exists to create opportunities for our clients, our people, and our communities through our industry-focused wealth advisory, digital, audit, tax, consulting, and outsourcing services. CLA (CliftonLarsonAllen LLP) is an independent network member of CLA Global. See CLAglobal.com/disclaimer. Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor.
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