The Inflation Reduction Act of 2022 (the "IRA")—President Biden's landmark climate change legislation—created or expanded tax credits for various renewable energy sources, including wind, solar, and hydropower, as well as for hydrogen production, carbon capture and sequestration, and manufacturing green energy technologies (collectively, "energy tax credits" or "credits").
While these energy tax credits are designed to subsidize the green energy transition, they differ from cash subsidies because taxpayers without regular income tax liabilities cannot directly benefit from them. To broaden the accessibility of energy tax credits, the IRA provides for the buying and selling of these credits for cash. Developers anticipated that this would lead to a robust market for energy tax credits, enabling them to monetize these credits without resorting to expensive tax equity structures.
Indeed, a robust market for energy tax credits is starting to develop. This article provides observations on the current state of this market.
General Observations
While we have seen the beginnings of a robust market for energy tax credits, we do not expect the market ever to treat energy tax credits like renewable energy credits or other intangible commodities. The risk profile for any given credit purchase depends on many factors, including the type of credit, the nature of the underlying project, and the creditworthiness of the seller. Moreover, transfers must occur directly between transferor and transferee taxpayers, though we have seen intermediaries play an active role in brokering transactions.
Before the IRA, tax credits could be monetized using tax equity structures. These structures are still available, but tax equity investors typically demand the right to cause the partnership to sell tax credits, with the tax equity investor retaining the proceeds.
Considerations for Energy Tax Credit Sellers
Buyers have been willing to pay between $0.85 and $0.95 per $1.00 of energy tax credit. Most market participants expect the price of energy tax credits to increase as the market continues to develop.
Regulations from the Department of Treasury and the Internal Revenue Service make the buyer of an energy tax credit responsible for a project's failure to qualify for the credits or, in some circumstances, recapture of the credits. Consequently, buyers demand measures to cover this risk. Sellers typically provide this coverage by procuring and bearing the costs of an insurance policy on the credits, often backstopped by an indemnity by a creditworthy affiliate.
While the IRA permits taxpayers to sell energy tax credits, it does not permit taxpayers to sell other beneficial tax attributes from a green energy project, such as depreciation. We have seen some investors willing to invest in projects using tax equity-like structures in order to benefit from these attributes together with a portion of the cash flow, while the project sells the credits to other investors for cash. Moreover, these investments can be structured to result in a tax basis step-up for the project, which can increase the amount of credits that a project can generate.
Sellers cannot sell an energy tax credit until the start of the taxable year in which the credit is earned, and they must sell the credit before the deadline for filing returns for the year in question (usually October 15 of the following year). This means sellers will need to find ways to bridge credit proceeds. For more information on monetizing energy tax credits, including using transferable credits to secure financing, see our White Paper, "Tax Credits for Sale: Opportunities for Financing Renewable Energy and Carbon Reduction Projects Under the Inflation Reduction Act."
Considerations for Energy Tax Credit Buyers
A buyer of energy tax credits benefits by paying less for the credit than its face value, thereby reducing the buyer's effective tax rate. This makes energy tax credits an attractive investment even for taxpayers that are not usually interested in investing in green energy projects.
Not all taxpayers can benefit from purchasing energy tax credits. Under the rules for passive activity losses and credits, individual taxpayers can only benefit from purchased credits in limited circumstances. Furthermore, starting in 2026, multinational companies may be able to enjoy a benefit from purchased credits only if the reduction in the effective tax rate does not result in additional tax under the new "Pillar 2" rules coming into effect in jurisdictions around the world. These rules generally impose a top-up tax if a company's effective tax rate in any jurisdiction in which it operates falls below 15%.
Insurance products generally provide comprehensive protection against the loss of credits and cover most types of recapture. However, they do not cover changes in law.
The market for buying and selling energy tax credits is still in its formative stages, but we expect that it will continue to strengthen. Jones Day has significant experience assisting buyers and sellers work through the relevant considerations.
Jacob Orlick, a summer associate in the Miami Office, assisted with the preparation of this article.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.