Financial service companies can benefit from Inflation Reduction Act tax credits by qualifying to claim them or by participating in the secondary market for them. Here’s a look at how to qualify and how to support sales of the credits.
The Inflation Reduction Act of 2022 (IRA) enacted or enhanced several energy tax credits and deductions that provide incentives for businesses that invest in renewable energy. In addition to the direct tax benefits available to taxpayers that meet the requirements, the IRA also created several ways for businesses to monetize the new credits.
These new IRA energy tax incentives and the related monetization options create a variety of tax-planning and business opportunities for financial service companies. Like any business, banks, credit unions, insurance companies, and other financial sector businesses can benefit from including clean energy upgrades when building or expanding their commercial real estate facilities. While the option to directly invest and claim credits is appealing, a potentially quicker and more lucrative approach to tax credits for financial services companies is through participation in the secondary market for IRA energy tax credits that other taxpayers may be looking to sell.
Financial service companies and the purchase of IRA energy tax credits
The IRA allows commercial taxpayers that invest in credit-eligible energy property to sell, or transfer, those credits to other taxpayers if the entity wants to directly monetize the tax benefit as quickly as possible. The transferability program through which applicable credits can be sold to buyers for cash provides accelerated cash benefits to both the buyer and seller of the credit. Generally, financial service companies with significant tax liabilities can benefit from the purchase of these credits at a negotiated discount. To that end, intended buyers must weigh both the costs and benefits of credit purchases and conduct proper due diligence prior to completing a transaction.
The process of transferring tax credits is treated almost identically to a M&A transaction. This includes steps such as initial letter of intent, due diligence, closing, etc. Credits are normally purchased at a discounted rate (typically in the 85–95 cents on the dollar range) allowing for a discounted relief of tax liability to the buyer. Worth noting is that taxable income is not recognized on the discount of the sales price and credits can only be transferred once. As such, purchases should be made with the intent to simply offset federal taxes at a discounted rate, not with an eye toward reselling the credit at a profit.
Although the purchase of a credit has many beneficial aspects, buyers should be wary of common pitfalls. For example, buyers will be on the hook for improperly claimed credits in scenarios where general qualifications and requirements of the credits were not met by the seller in the first place. Furthermore, recapture rules apply when sellers of credits dispose of the underlying credit eligible asset prior to the required recapture period. As such, buyers should consider additional steps to the process:
- Credit due diligence. Once a tax credit is transferred, the transferee who claims the credit on its return bears the responsibility for any disallowance of the credit by the IRS. Just like an M&A transaction, the buyer may want to engage an independent third party to perform thorough due diligence to verify that the seller has met the requirements to qualify for the credit it proposes to transfer. Proper due diligence can ultimately limit penalties in the case of a future credit disallowance. Additionally, buyers need to ensure the transfer agreement includes terms that require the seller to maintain the property in the manner necessary to continue credit eligibility.
- Insurance for credit purchasers. With so many variables in play in this relatively new market for tax credit sales, tax insurance can provide helpful protection. Tax insurance has become commonplace in many M&A transactions and such coverage has been extended to credit transactions. Importantly, the insurance underwriting process involves examination of the tax credits, which mirrors tax due diligence. Obtaining tax insurance provide may provide a buyer with additional peace of mind about the financial ramifications of potential IRS examinations and possible disallowance of the credit.
- Modeling to project tax credit needs. A financial service company seeking to purchase tax credits should complete modeling to understand its anticipated tax liability and its ability to utilize purchased credits. One key nuance involves entities that are characterized as partnerships or S corporations for tax purposes since purchased credits are subject to passive activity rules at the partner or shareholder level. Such rules may prevent individuals from fully offsetting the purchased (passive) credits against federal income tax liabilities related to active business income.
- Procedural steps. The IRA provisions that allow for the sale of these credits also impose some specific procedural requirements on transfer transactions. For example, the seller must complete a pre-filing registration with the IRS and obtain a registration number, a process that the IRS recommends initiating at least 120 days before a tax filing deadline. The buyer and seller both must make valid transfer elections by the due date of their tax return for the year in question (including extensions), and consideration must be paid to the seller in cash (or a limited few designated cash equivalents) within a time period set forth in regulations.
IRA tax benefits for financial service companies that invest in renewable energy property directly
While the quickest benefit to financial service companies may be through the purchase of tax credits through the secondary market, these entities can also benefit from investments into various technologies and improvements themselves. Banks and other financial sector businesses that make capital investments into renewable energy may qualify for the following incentives:
- The Investment Tax Credit under IRC Section 48/48E for investments into various renewable energy technologies, including solar, wind, geothermal, battery energy storage, and more. Credit enhancements and bonus credit amounts are available depending on a variety of factors.
- Clean vehicle credits available specifically for commercial use under IRC Section 45W. This includes the purchase of qualified electric or plug-in hybrid vehicles.
- Credits for alternative fuel refueling property (such as charging stations) under IRC Section 30C installed by businesses located in certain nonurban or low-income census tracts.
- An energy-efficient commercial buildings deduction under IRC section 179D when placing in service certain qualifying new or renovated energy-efficient building property upgrades.
Generally, when claiming a tax credit or deduction for these types of capital investments, careful analysis of the rules and requirements is vital. Tax credits specifically can offset up to a maximum of 75% of a taxpayer’s tax liability for a given year. Claiming these credits requires thorough documentation and support and filing property specific information on a taxpayer’s normal annual tax filing.
Planning ahead to maximize benefits
Whether a financial service company wants to participate in the secondary market for the purchase of credits or qualify for IRA tax credits themselves, it pays to plan ahead. The rules in this area can be quite nuanced and require careful consideration to the details. Regardless, beneficial opportunities exist, especially to financial service companies.
To learn more about the benefits that IRA energy tax credits can provide for financial service companies, please consult with your tax advisor.
