Energy tax credits modified or created by the Inflation Reduction Act nearly three years ago may see significant changes under the Trump administration. Parties to tax credit transfer agreements can protect themselves against risk in this environment of uncertainty by negotiating stronger changes in legal protections in transfer agreements and transactional tax insurance policies.
On the legislative side, the new energy tax credits may be on the chopping block as a revenue raiser to offset the cost of extending the Tax Cuts and Jobs Act's expiring provisions as part of a larger tax reform legislation expected to be considered by Congress.
If Republicans can't gather enough votes to repeal the new energy credits, Congress may make more narrow changes, such as shortening the eligible time frame to claim certain energy tax credits, adding foreign entity of concern restrictions to additional energy tax credits, or repealing the transferability and direct pay provisions.
The Trump administration will review and potentially modify existing guidance for the new energy tax credits stemming from the 2022 tax and climate law. Although any repeal or modification of final regulations would require complying with the Administrative Procedure Act's notice and comment requirements, changes to subregulatory guidance could be achieved more quickly and sidestep the notice-and-comment process.
Additionally, the IRS is facing significant funding challenges and potential workforce reductions, which may impact the ability of the agency's to timely issue registration numbers, which are required to transfer credits.
What does all this uncertainty mean for buyers and sellers of tax credits?
In a typical credit transfer deal, the risk of credit disallowance or recapture is on the buyer, so buyers are generally concerned with the risk that the credit might be disallowed by the IRS or subject to a recapture event.
Buyers protect against these risks in a few ways:
- Performing due diligence to ensure that the seller qualifies for the tax credit
- Negotiating strong indemnification provisions to require the seller to reimburse the buyer if the credit is ultimately disallowed or recaptured (which may be backed by a guaranty of the seller's owner)
- Obtaining tax insurance to cover disallowance or recapture of the tax credit (before a seller indemnity kicks in). Tax insurance has become common in tax credit transfer deals, particularly for investment tax credits, unless the credit amount is too small to make it economical
But how do buyers protect themselves from a change in law that impacts the existence or amount of the tax credit?
Fortunately, the structure of the transferability provision limits the scope of the risk of legal changes. This is because there is a limited period for transferring and paying for credits—the year they are generated up until the filing of the original tax return claiming the credit.
Although buyers can contract in advance to purchase a tax credit through a forward transfer agreement, they can't pay for or receive a credit until that timeframe. As a result, if a particular credit is modified or repealed prospectively, it won't upset closed deals. And repeal or modification of taxpayer-favorable provisions or regulations retroactive to a prior tax year is highly unusual.
This leaves the risk of legal changes affecting 2025 or future years. For example, forward transfer agreements involve a current contract to purchase a credit generated in a future year. We may start to see a reduction in forward credit purchases due to the uncertainty in the law.
Buyers also may limit such purchases to so-called safe harbor projects. These are renewable energy projects that meet the "begin construction" safe harbor rules in 2024, which would subject them to the rules in effect in 2024 and protect them from future changes in the tax credits.
Another thing that buyers can do is add or strengthen change-in-law provisions to their agreements and tax insurance policies.
Generally, if the purchase price is to be paid after the transfer agreement is executed, one of the funding conditions typically is that the law doesn't change—including the statute, regulations, other controlling administrative guidance, or court a ruling—that could adversely affect the tax credits at issue in a material way.
These change-in-law provisions could be extended beyond funding, requiring a return of purchase price (along with indemnification for other related damages such as penalties or transaction costs) in the event of an adverse change in law that occurs after the funding date.
Although tax insurance policies typically cover retroactive changes in law, they exclude prospective changes in law from coverage. In this environment of legal uncertainty, parties could work with their tax insurers to include certain well-defined prospective law changes in the policy.
Another contingency that parties to transfer agreements should protect against is the chance that the IRS is unable to timely issue a registration number.
If parties enter into a transfer agreement before the transfer registration portal is open for that year, the agreement usually provides that the transfer election statement attached to it isn't required to include a registration number.
But the parties generally anticipate the registration number will be issued before the transfer election statement is filed, which might not be the case in light of the IRS workforce reductions. We anticipate that the IRS would need to provide guidance on what to do in that event, but the parties should consider this in their negotiations.
At a time when the IRS is facing workforce and funding reductions that may affect future audits, Congress and the Trump administration should favor maintaining the transferability provisions. Transferred credits potentially undergo multiple levels of review by the tax credit buyers, tax insurers, and project sponsors, increasing the chances that the tax credit is being properly claimed.
Buyers and sellers are transferring 2025 energy tax credits during a turbulent time in government. They should closely monitor legislative and regulatory changes that may affect credit eligibility and transferability and make sure their agreements protect against changes in the law in 2025 and future years.
Originally published by Bloomberg Tax.
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