Elective Pay and Transferability

In the ever-evolving maze of business finances, the importance of timely estimated tax payments cannot be overstated. Failing to do so could mean facing high penalties in the 4th quarter.

Picture this: Your business had an exceptional year, revenues soared high, and suddenly, you are disillusioned by surprisingly hefty tax penalties.

You did everything by the book but forgot about regulations' recent changes!

This guide focuses on preventing penalties for 4th quarter estimated tax payments, ensuring unexpected fiscal liabilities don't slice your hard-earned profits.

Let’s dive in!

What Is Estimated Tax?

Elective pay, a system created under the Inflation Reduction Act, enables entities without federal income tax to claim direct payment equivalent to the total value of applicable tax credits for building clean energy projects or making qualified investments. By declaring their intent to the IRS, those eligible for the system can access the total value of the credits.

The game-changing system, intended to further the impact of the IRA, allows small businesses, governments, nonprofits, and start-ups to benefit from its force-multiplier effect.

Please note that this should not be confused with direct pay, another IRS payment method.

Eligibility

1. Tax-exempt organizations, States, local governments, Indian tribal governments, Alaska Native Corporations, the Tennessee Valley Authority, rural electric cooperatives, U.S. territories and their political subdivisions, and agencies and instrumentalities of state, local, tribal, and U.S. territorial governments can all use elective pay.
2. According to Section 501(a) of the Internal Revenue Code of 1986, organizations exempt from tax can elect to receive pay. This includes public charities, private foundations, social welfare organizations, labor organizations, business leagues, religious or apostolic organizations under Section 501(d), and other organizations described in Section 501(c).
3. States, political subdivisions (e.g. cities, counties), their agencies and instrumentalities (e.g. water districts, school districts, economic development agencies, public universities and hospitals) are all eligible for elective pay. This includes the District of Columbia.
4. Tribal governments, political subdivisions, and their agencies and instrumentalities are eligible for elective pay. "Indian tribal government" is defined as the governing body of any Indian or Alaska Native tribe, band, nation, pueblo, village, community, component band, or component reservation included in the Department of the Interior's Federal Register list under the Federally Recognized Indian Tribe List Act of 1994.
5. Alaska Native Corporations, as defined by Section 3 of the Alaska Native Claims Settlement Act (43 U.S.C. 1602(m)), including Regional Corporations, Village Corporations, Urban Corporations, and Group Corporations, are eligible for the program, provided they are organized under Alaska state law. Settlement Trusts may also be eligible if they have qualified for and received exempt status under Section 501(a) and a determination letter from the IRS.
6. Eligible for elective payments are U.S. territories, their political subdivisions, and their associated agencies and instrumentalities.
7. Tax-exempt rural electric cooperatives are eligible to use elective pay for all 12 credits listed in Q13. Non-tax-exempt cooperatives may use elective pay for all credits except the Commercial Clean Vehicles credit (45W). This use of elective pay does not affect the 85-percent income test for tax-exempt electric cooperatives.
8. Tennessee Valley Authority is an eligible entity.

Special rules that limit the application of the credits in the territories

• Investment-related tax credits (sections 30C, 45W, 48, 48C, and 48E) gained from property used in the US (fifty states + DC) must generally be owned by a US corporation or citizen (except those entitled to the benefits of sections 931 or 933).
• Property owned by a US territory or an entity created in or organized under the laws of a US territory does not qualify for these credits. However, these restrictions do not apply to the production credits eligible for elective pay (sections 45, 45Q, 45U, 45V, 45X, 45Y, and 45Z)

Type of property ownership required for projects using elective pay

Generally, the entity or taxpayer that wants to take the credit must own the eligible credit property.

In certain cases, they don't need to own it but must do activities that result in the eligible credit. For instance, to be eligible for a Section 45X credit, the taxpayer must manufacture and sell eligible components to an unrelated party.

Applicable credits

Per the IRS, here’s the list of credits you can access via the elective pay system.

• “Energy Credit (48), (Form 3468, Part VI)
• Clean Electricity Investment Credit (48E), (Form 3468, Part V)
• Renewable Electricity Production Credit (45), (Form 8835, Part II)
• Clean Electricity Production Credit (45Y)
• Commercial Clean Vehicle Credit (45W), (Form 8936, Part V)
• Zero-emission Nuclear Power Production Credit (45U), (Form 7213, Part II)
• Advanced Manufacturing Production Credit (45X), (Form 7207)
• Clean Hydrogen Production Credit (45V), (Form 7210)
• Clean Fuel Production Credit (45Z)
• Carbon Oxide Sequestration Credit (45Q), (Form 8933)
• Credit for Alternative Fuel Vehicle Refueling / Recharging Property (30C), (Part 8911, Part II)
• Qualifying Advanced Energy Project Credit (48C), (Form 3468, Part III)”

Source: www.irs.gov

An applicable entity can use elective pay for 12 credits if it meets the requirements. There are place-in-service date restrictions for sections 45, 45Q, and 45V. Elective pay for the Commercial Clean Vehicle Credit (45W) is only available to organizations exempt from the tax by section 501(a) or for a State, the District of Columbia, a U.S. territory, an Indian tribal government, a subdivision thereof, or an agency or instrumentality of any of the foregoing.

Bonuses

Facilities beginning construction in 2024 may earn a 2% increase in Production Tax Credit and a 2-point bonus in Investment Tax Credit if domestic content requirements are met. Failure to meet the requirement may reduce the earned credit.

The domestic content bonus consists of two parts:

Steel and Iron Requirement (requiring products to be 100% made in the U.S.) and Manufactured Product Requirement (satisfied if all component "manufactured products" are produced or “deemed” to be produced in the U.S.).

For a manufactured product to be considered produced in the U.S., all manufacturing processes must have occurred in the U.S., and all components must be of U.S. origin (regardless of subcomponent origin).

The same applies for “deemed” production but with a domestic manufacturing percentage (further determined as all domestic manufactured products and domestic component costs divided by total manufactured product costs): 40% for projects before 2025, 45% for 2025, 50% for 2026 and 55% for thereafter.

The Zero-Emission Nuclear Power Production Credit increases to 10% if the prevailing wage and apprenticeship requirements are satisfied.

Employers must pay Davis-Bacon Act prevailing wages to workers on applicable projects and use registered apprentices.

The requirements also apply to the Alternative Fuel Refueling Property Credit Production Tax Credit, the Credit for Carbon Oxide Sequestration Credit for Production of Clean Hydrogen, the Clean Fuel Production Credit Investment Tax Credit, the Advanced Energy Project Credit, and the Energy Efficient Commercial Buildings Deduction.

Grants and loans

Entities can combine forgivable loans with tax credits under the proposed guidelines.

If a tax-free grant or forgivable loan funds a qualifying purchase, entities will receive the same value of the eligible tax credit as if the investment was funded with taxable money, provided the total cost of the credit and tax-exempt funds does not exceed that of the investment and involves credit property listed in sections 30C, 45W, 48, 48C, or 48E.

What Is Transferability?

Entities eligible for tax credits but not elective pay can transfer all or part of their credit to a third-party buyer in exchange for cash. Both parties agree to the terms and pricing. IRA enables businesses that cannot take advantage of elective pay to transfer their qualifying clean energy credits to a third party for immediate, tax-free funds.

This overcomes the challenge of entities without sufficient tax liability not being able to use their credits and incurring high costs fully.

Transferability has certain aspects that concern taxpayers, policymakers, and the IRS due to the substantial risks associated with these transactions. This can include uncertainties regarding the credits' respective market values, evaluations of an agreement's revenue potential, inspection and enforcement-related challenges, and the possibility of unclaimed credits being left "abandoned."

These must be managed properly to enable successful credit trading and ensure the program's viability.

An effective measure often put in place involves caps on total awards to prevent parties from taking undue advantage of the provisions. Additionally, policymakers and the IRS can work together to devise stringent administrative provisions to uphold compliance without adversely affecting legitimate operations.

Eligible credits

Taxpayers not meeting the criteria of an applicable entity under elective pay can transfer (sell) any of eleven eligible credits:

1. 30C Alternative Fuel Vehicle Refueling/Recharging Property Credit (Part 8911, Part II);
2. 45 Renewable Electricity Production Credit (Form 8835, Part II);
3. 45Q Carbon Oxide Sequestration Credit (Form 8933);
4. 45U Zero-emission Nuclear Power Production Credit (Form 7213, Part II);
5. 45V Clean Hydrogen Production Credit (Form 7210);
6. 45X Advanced Manufacturing Production Credit (Form 7207);
7. 45Y Clean Electricity Production Credit;
8. 45Z Clean Fuel Production Credit;
9. 48 Energy Credit (Form 3468, Part VI);
10. 48C Qualified Advanced Energy Project Credit (Form 3468, Part III); and
11. 48E Clean Electricity Investment Credit (Form 3468, Part V).

What To Do To Transfer Eligible Credits

1. Launch a project that meets the required criteria for a credit.
2. Register electronically with the IRS before filing your entity's tax return to ensure you have a valid registration number.
3. To qualify for the credit, requirements must be met in the relevant tax year. For example, if seeking the 45 Renewable Electricity Production Credit, a taxpayer must establish and maintain a clean energy electricity generation facility within the required tax year.
4. Transfer an eligible tax credit to an unrelated party for cash.
5. Give the buyer the registration number and all other required data to apply for the eligible credit.
6. Create a transfer statement together with the person receiving the transfer.
7. File a tax return by the due date (including extensions) for the taxable year in which the eligible tax credit is determined. Include a transfer election statement, registration number for the relevant eligible credit property, and any other information required by guidance. All facilities need their own registration number. However, when transferring a tax credit from one party to another, the same registration number is given to all recipients of the eligible credit property.

Lastly, renew pre-filing registrations and file returns annually if transferring an eligible credit related to the eligible credit property.

To purchase and claim transferred eligible credits, an entity must:

1. Arrange to purchase an eligible credit from an unrelated party in exchange for only cash
2. Obtain the transferor's registration number of eligible credit property generating the credit and all related info necessary to claim credit
3. Complete a transfer election statement with the transferor
4. File a tax return for the relevant taxable year, including transfer election statement & registration number for eligible credit property
5. The order of filing returns by the transferee and transferor does not matter

The transferor and transferee must attach a transfer election statement to their tax returns for the respective year.

The statement should include:

• Names
• Addresses
• Taxpayer identification numbers
• Description and amount of credit transferred
• Cash paid
• Registration number of eligible property
• Specific statements from the parties involved

Please note: Sections 48, 48E, 48C and 45Q carbon sequestration credit transfers require the transferee to take financial responsibility for any recapture event that occurs. The transferor must notify the transferee if a recapture is required. No other eligible credits require recapture.

Tips for Successfully Transferring Eligible Credits

Despite the complexity of the procedure, there are several key actions you can take to make credit transfers smoother.

1. Clearly understand federal and state law requirements: A good understanding of the law can help ensure compliance, preventing future complications.
2. Collaborate with expert tax advisors: Their knowledge can assist organizations navigate intricacies involved in the smooth transfer of credits.
3. Create comprehensive documentation: Keeping meticulous records such as transfer statements, registration numbers and more can facilitate the process for parties involved over time.
4. Install adequate internal controls: This aids in preventing errors that could jeopardize a successful transfer.
5. Consider stipulating terms to handle any recapture: Arrange precautions in the contract to deal with possible recapture events, especially with credits requiring recapture.
6. Ensure sufficient operational observance: Develop an astute oversight mechanism especially for projects funded via credit transfer to ensure they meet multiplier bonus requirements since they affect the amount of credits retrieved.
7. Run regular audits: Performing frequent checks can help ensure accuracy and compliance with the procedures stipulated by the IRS.
8. Plan ahead for transfer setup: As transfers can take time, it's crucial to start the process early enough, especially for renewable credit programs, which might have designated set-up windows.
9. Specified use of cash proceeds: Detailing and specifying the way cash is procured as payment would be used to the biased satisfaction of buyer and seller increases chances of smoother transfers.
10. Stay updated with regulatory changes: The world of regulations is dynamic. Regular updates will make you stay ahead, ensuring that you are always eligible for credits.
11. Execute legal agreements judiciously: Both the transferor and transferee should execute legal instruments for purchasing and selling credits. This ensures record tracing and smooth functioning of the transfer.
12. Make projects independent: Ensure that each project stands on its own merit. Taking independent charge helps, especially when a property consists of multiple facilities.
13. Reevaluate analyses: Reassessment of ecological and fatigue instances matter. From time to time, delve into reconsidering and upkeeping prevalent revisit analyses which validate the permit transfer.

To Recap

Elective pay and credit transferability present complexities, but a straightforward approach simplifies the process. Focus on accuracy and legality rather than speed, and comply with federal and state requirements.

Consult tax professionals to maximize credits, keep current with regulations and record-keeping, and review procedures regularly.

Adopt strategic planning to expedite and stabilize legal processes and ensure projects are self-reliant, and review profitability metrics to sustain scalability.

FAQs

What is elective pay?

Elective pay refers to compensation options provided by an employer, which an employee has the right to choose. This can include several elements such as bonus payments, differing salary increments, or changes to employment terms and conditions.

What is credit transferability?

Credit transferability refers to the ability to move a tax incentive or credit from one party to another. This can help the transferring party to generate cash, while the receiving party can lower their net tax expense.

Can a recapture event occur?

Yes, recapture events can occur under Sections 48, 48E, 48C, and 45Q carbon sequestration credit transfers. The transferee becomes financially responsible for any recapture event that happens. The transferor is required to notify the transferee if a recapture would be needed. Other eligible credits do not require recapture.

What is the role of the transferor and transferee?

The role of the transferor is to sell the tax incentive or credits to an unrelated party in return for cash. Then provide all the necessary info for the transferee to claim credit.