Tax Credit Transferability and Direct Pay Proposed Under the IRA
Potential for interactions with Section 174 complicate a seemingly simple program

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The new tax credits in the Inflation Reduction Act (IRA) mean that more taxpayers will have access to more tax credits in the near future. But recent guidance highlights some uncertainties that taxpayers should be aware of before jumping in.

The Treasury Department and the Internal Revenue Service recently released proposed regulations regarding clean energy tax credits—also called “green tax credits”—that would be eligible for direct pay and transferability under the Inflation Reduction Act.1 This article summarizes the proposed regulations concerning transferability and direct pay and provides high-level discussions of comments submitted in response to those proposed regulations and of the interaction of, and potential for increased audits due to, Section 174 of the Internal Revenue Code and these green tax credits.2

An important concern this article raises, among others, is that the green tax credit transferability rules aim to subsidize innovations in renewable energy projects and technology, but Section 174 looms in the background—and may chip away at any cash a company raises through transferring credits.

Green Tax Credits

To help fund innovation and production in clean energy, the government enacted the IRA, paving the way for landmark tax policy via transferability and direct pay. This legislation permits most taxpayers to monetize otherwise unused (or underused) tax credits by allowing producers of tax credits to sell (transfer) tax credits to taxpayers who can use them to offset tax liability. Direct pay also allows monetization of tax credits by certain tax-exempt organizations by granting such organizations direct cash payments (in the form of refunds) for eligible tax credits. A key difference between the transferability and direct pay rules is that direct pay is accessible only to qualifying tax-exempt organizations. Taxpayers who do not qualify for direct pay must use the transferability market to monetize or purchase tax credits (which, presumably, are purchased at a discount).


Taxpayers eligible for qualifying green tax credits may transfer credits to unrelated third parties.3 Some key clarifications in the proposed regulations include the following:

  • Transferees must pay for the credit in cash (that is, cash, check, cashier’s check, money order, wire transfer, ACH transfer, or other bank transfer of funds that are immediately available);
  • The credit can be essentially parceled, subject to certain rules dealing with bonus credit portions, and transferred by a transferor to multiple transferees. However, according to the so-called “no second transfer” rule, the first transferee or transferees cannot transfer the credit to anyone else;4
  • Among other requirements for transfer, the IRS will launch (by the end of 2023) a prefiling registration portal that will require sellers of tax credits to provide certain information before transferring a tax credit, such as specific details of the eligible property giving rise to the tax credit;
  • Once made, transfers are irrevocable, and credits cannot be transferred back to the transferor or transferred to another party. The regulations clarify that brokers can foster relationships between transferors and transferees, but may not purchase credits and then transfer them to subsequent transferees;
  • Recapture events are possible and the burden generally rests with the buyer (or transferee) of the credit, although the transferor must notify the transferee of the recapture event;5 and
  • The passive activity rules generally apply with respect to structures involving partnerships and similar arrangements. The passive activity rules are complex and beyond the scope of this article.

Direct Pay

Various credits outlined in the IRA allow taxpayers who fall within the definition of “applicable entities” to receive a cash payment from the government for eligible tax credits rather than apply the credit on their tax return.

The following “applicable entities” are generally eligible for direct payment: tax-exempt organizations, states, and political subdivisions such as local governments, Indian tribal governments, Alaska Native corporations, the Tennessee Valley Authority, rural electric cooperatives, US territories and their political subdivisions, and agencies and instrumentalities of state, local, tribal, and US territorial governments.6 Among other helpful clarifications, the proposed regulations further define “applicable entities” as follows:

  • Organizations exempt from the tax imposed by subtitle A—the proposed regulations clarify that organizations under Section 501(a) can qualify, along with any government of a US territory;
  • State or political subdivisions—Treasury and the IRS have confirmed that the District of Columbia is an “applicable entity” for these purposes;
  • Indian tribal government—the proposed regulations define an Indian tribal government as any Indian or Alaska Native tribe, band, nation, pueblo, village, community, component, or component reservation individually identified in the Federally Recognized Tribes list published by the Department of the Interior; and
  • Water districts, public universities, and hospitals—the FAQs clarify that these qualify as “applicable entities” under the rules.

Comments Responding to Proposed Regulations

The Treasury Department and the IRS have received comments on both the Section 6417 (direct pay) and Section 6418 (transferability) proposed regulations, held a hearing on the direct pay proposed regulations on August 21, 2023, and held a hearing on the transferability proposed regulations on August 23, 2023. Interested parties submitted 149 comments to the IRS on the direct pay proposed regulations and eighty-one comments on the transferability proposed regulations. Due to the large number of comments, this article does not discuss all of them. The comments described below were chosen because they either showed a trend among numerous commentators or presented an interesting issue.

Direct Pay Comments and Hearing

Some of the common themes in the comments related to direct pay included: 1) modifying rules to allow direct pay for transferee taxpayers;
2) timing of direct payments; and 3) requests for reconsideration of the treatment of partnerships and S corporations.

Commentators at the direct pay hearing on August 21 suggested that taxpayers who purchase a credit should be allowed to elect direct pay under Section 6417. These commentators proposed that under the statute a transferee taxpayer should be treated as the owner of the transferred credit for all purposes of the Code, with the ability to elect direct pay. However, the proposed regulations do not allow a transferee taxpayer to elect direct pay; instead, to elect direct pay, the taxpayer must own the underlying eligible credit property.

Other commentators noted the need for more certainty about the timing of direct payments. At the hearing, one company stated that under the current rules, taxpayers would have to have investments in place, register with the IRS, file a tax return, and then wait for the return to be processed before receiving a direct payment, a process that would take about 3.5 years. The company noted that for the capital-intensive projects with which it is involved, getting funding from banks and stakeholders is difficult due to the uncertainty surrounding when direct payments would be received.

Last, commentators requested that Treasury and the IRS reconsider the proposed rule that partnerships and S corporations are not applicable entities for purposes of direct pay for certain credits, even if partners or shareholders are applicable entities. One hearing participant advocated for allowing partnerships and S corporations to elect direct pay because partnerships are common and important in the energy tax credit industry, with renewable energy developers providing expertise and experience in performing projects while allowing investors to participate in partnership structures, particularly for larger projects.

Transferability Comments and Hearing

Common themes in comments relating to transferability included 1) requests for a broadened or clarified definition of the “specified credit portion” allowed to be transferred; 2) a need for clarification regarding whether Section 469 passive activity rules should apply to Section 6418 transfers; and 3) concerns about the prefiling registration process and suggestions to streamline it.

“Specified Credit Portion”

The proposed regulations allow for taxpayers to transfer any “specified credit portion,” defined as a proportionate share (including all) of an eligible credit determined with respect to a single eligible credit property of the eligible taxpayer that is specified in a transfer election. The proposed regulations further require that a specified credit portion of an eligible credit must reflect a proportionate share of each bonus credit amount that is taken into account in calculating the entire amount of eligible credit determined with respect to a single eligible credit property.

Several commentators asked that a revised definition of a specified credit portion include not only the above definition but also a second definition whereby a specified credit portion would mean any one or more specified base or bonus credit portions. Commentators noted that the Section 6418 statute does not restrict the portion of a credit that may be transferred to a proportionate share of the base and bonus credit together and that Congress intended to allow for a broad interpretation of a “portion” that may be transferred.

One commentator explained that if a buyer is required to purchase a portion of the base credit and any bonus credit, such as for prevailing wage and apprenticeship, domestic content, low-income, and/or energy community provisions, the buyer would need to conduct due diligence on each piece of the credit. The buyer would be required to retain a professional with expertise in all of these areas, potentially making the transaction more costly and less attractive to buyers. The risk associated with buying a credit portion of both the base and different bonus credits likely will differ, too. If instead a buyer could buy a portion of just the base credit or a portion of just one of the bonus credits, the due diligence required could be narrower, allowing for a broader market of buyers with different levels of risk tolerance and potentially lower transaction costs.

Section 469

Several commenters requested that the final regulations should be revised so that the passive credit rules under Section 469 do not apply when a credit is transferred under Section 6418. The passive activity credit rules require that passive losses can be used only to offset passive income and define a passive activity as one in which the taxpayer did not materially participate during the year in question. A transferee taxpayer who purchases tax credits from a third party will never hold an ownership interest in the entity generating the tax credits, and therefore cannot meet the material participation tests under Section 469. Under the passive activity credit rules, transferee taxpayers only would be able to use purchased tax credits to offset passive income from other sources, which commentators argued could reduce interest in purchasing tax credits and make monetizing credits more difficult.

Some commentators pointed out that Section 6418(a) provides that a transferee of an eligible credit shall be treated as the taxpayer for purposes of this title with respect to such credit (or such portion thereof). This could mean that a transferee taxpayer would step into the shoes of the transferor taxpayer, without facing the application of rules, such as the passive activity rules, limiting the further use of the tax credits. One commentator suggested that the transferee taxpayer who purchases tax credits should be treated as being engaged in the activity of investing and not subject to the passive activity credit rules.

Reporting and Registration Issues

The proposed regulations provide that eligible taxpayers must complete a registration process before filing the tax return on which a transfer election is made. After completing this prefiling registration process, the IRS will assign an eligible taxpayer a unique registration number for each registered eligible credit property for which that taxpayer intends to transfer a specified credit portion. Several commentators expressed concern about potential delays in the IRS’ review and registration number issuing process, particularly if the IRS intends to preaudit or pre-certify each filing. Commentators suggested solutions, including allowing taxpayers to aggregate eligible credit properties that are part of the same project and streamlining the process for certain eligible taxpayers that do not present administrative concerns.

Uptick in Audits and Litigation Likely

The IRS already has experience with tax credits and monetizing them. Congress enacted Section 1603 of the American Recovery and Reinvestment Tax Act of 2009, which put in place a cash grant program to incentivize renewable energy projects. The program gave cash grants of ten to thirty percent of the capital costs for renewable energy projects. The program issued over $20 billion in grants while it was in effect but also led to significant litigation. Grant recipients disputed Treasury’s awards in many areas. For example, significant disputes arose regarding what costs were included in the cash grant calculation. Projects also argued that Treasury improperly excluded property that should have been “qualified” given that it was integral to electricity-generating activity. Finally, valuation disputes arose regarding, for example, related-party developer fees included in the calculation. These disputes, which dragged on for years, complicated a program that appeared simple on its face.

Following its experience with Section 1603, the government is likely to be on high alert for overreaching and fraud by projects attempting to take advantage of credits by inflating calculations. Because the government succeeded in some of the Section 1603 cash grant litigation, it likely will examine and challenge taxpayer calculations in the IRA arena. The IRS may focus on claims for IRA credits, especially issues such as which property is properly included as a part of the project, related-party costs, valuation, bonus credit amounts, and calculating credits when projects are purchased.

Section 174

Recent changes to the rules in Section 174 require taxpayers to capitalize and amortize certain research and development (R&D) expenses instead of taking an immediate tax deduction under Section 162 of the Code. The changes to Section 174, passed as part of the 2017 Tax Cuts & Jobs Act, were assumed to be a revenue raiser to offset the tax breaks that were also part of the same legislation.7 Many thought these changes would be reversed prior to becoming effective for tax years after December 31, 2021. Although the details of the technical rules of Section 174 are beyond the scope of this article, it is worth noting that the Section 174 rules arguably conflict with the policy intent behind the green tax credits. On the one hand, the government encourages energy producers to sell green tax credits to tap into much-needed capital, but, on the other hand, these same companies face being whipsawed by the Section 174 changes, which now result in many companies having to amortize R&D costs over five or fifteen years, depending on whether the costs are from US activities or foreign activities, instead of enjoying immediate tax deductions under Section 162 of the Code.

Taxpayers are struggling to parse the R&D expenses that fall within Section 174 from those that do not, and thus which expenses do not qualify for immediate tax deductions under Section 162 and which do. This difficulty means that some smaller producers of renewable clean energy may face a tough path forward—although transferability means a welcome infusion of capital, significant costs and burdens await taxpayers who have to comply with Section 174, in addition to the uncertainty of which expenses fall under it. The more granular concern is that the attendant cost of Section 174 compliance and audit risk may eat away at some, or possibly all, of the benefit that smaller producers receive by transferring green tax credits. Further uncertainty is attached to determining how to allocate operating and nonoperating expenses under Section 174, with the likelihood that more operating expenses must be amortized instead of being immediately deductible. This scenario can leave cash-strapped producers in a tough spot—while welcome cash comes in the door via green tax credit transferability, net tax bills may go up for these same producers, who must now amortize more of their expenses under Section 174, prolonging the tax benefit related to the deduction of such items.

The IRS and Treasury should issue guidance to alleviate the whipsaw potential created by Section 174 and to clarify how these rules interact with the policy behind transferability and green tax credits.

Perhaps the problem is the speed with which tax legislation seems to be enacted these days, but without guidance or a complete reversal of the Section 174 changes, the benefit of green tax credit transferability may be severely limited by Section 174’s impact on small and mid-market producers.

Managing Audit Risk (or at Least Streamlining the Audit Process)

Taxpayers can prepare to address the limitations of Section 174 and general concerns over upticks in tax audits by taking some of the following actions to minimize (or at least make more palatable) the audit process:

  • Due diligence. Diligence is key to supporting green tax credits. While the IRS will include some level of responses aimed at a cursory level of diligence when transferors (sellers) of green tax credits register on the IRS portal, parties to a transferability arrangement should consider the need to engage in detailed, typical commercial-style diligence. One area that may require more diligence is where a buyer of green tax credits seeks cover through an insurance policy for recapture events.
  • Section 174 documentation. Taxpayers will need to keep good records showing how they determined which expenses fall within the scope of Section 174 and which fall outside it. Further, the methods used to determine ancillary costs, such as utilities, wages, and similar items for mixed-use functions, should also be considered carefully and documented in case of an audit.
  • Drafting of transferability agreements. Parties to transferability agreements should closely evaluate the need for M&A-style provisions around indemnification and cooperation with respect to recapture events. For example, a buyer may benefit from negotiating full participation and settlement approval rights over any audit of a green tax credit if the buyer will ultimately be called upon to be financially responsible for any underpayment of tax associated with a recapture event.


Green energy credits and the transferability and direct pay rules offer an extraordinary opportunity to taxpayers who generate these credits and those who could benefit from buying them. To mitigate risks associated with these opportunities, taxpayers need a clear understanding of the rules around these credits and their interaction with Section 174 to plan up front and to anticipate potential audits or litigation.

Starling Marshall​, ​​​Christine Lane, and Carina Federico are partners at Crowell & Moring LLP.

Editor’s note. The IRS recently issued a notice (IRS Notice 2023-63) providing additional guidance with respect to Section 174 and announcing that the Treasury Department and IRS intend to issue proposed regulations aligned with the notice. It is anticipated that the proposed regulations will apply for taxable years ending after September 8, 2023. The notice further provides that prior to the publication date of the proposed regulations in the Federal Register, a taxpayer may choose to apply the rules described in the Notice for taxable years beginning after December 31, 2021, provided the taxpayer applies all of the key provisions in the notice and such rules are applied by the taxpayer in a consistent manner. The notice and forthcoming proposed regulations indicate that these rules are likely here to stay for the foreseeable future.


  1. Elective Payment of Applicable Credits, Proposed Treasury Regulations Section 1.6417, 88 Federal Register 40528 (June 21, 2023) and Transfer of Certain Credits, Proposed Treasury Regulations Section 1.6418, 88 Federal Register 40496 (June 21, 2023). The IRS also released FAQs for both direct pay and transferability, which provides further guidance to interested taxpayers. See Elective Pay and Transferability Frequently Asked Questions, available at (June 14, 2023).
  2. This article discusses the comments on the proposed regulations as of the date this article was authored (November 7, 2023).
  3. Generally, the following tax credits may be eligible for transfer: Alternative Fuel Vehicle Refueling Property (Section 30C), Electricity Produced From Renewable Resources (Section 45), Carbon Capture Sequestration (Section 45Q), Zero-Emission Nuclear Power Production (Section 45U), Production of Clean Hydrogen (Section 45V), Advanced Manufacturing Production (Section 45X), Clean Electricity Production (Section 45Y), Clean Fuel Production (Section 45Z), Clean Electricity Investment (Section 48), Advanced Energy Project (Section 48C), and Clean Electricity Investment (Section 48E).
  4. Generally, the credit amount cannot be separated from any “bonus” credit portions (that is, taxpayers cannot transfer a portion of an eligible credit related solely to a bonus credit amount). If an entire credit is transferred, the entire bonus credit must be included in the transfer. If a portion of the credit is transferred, the same proportional amount of any bonus credit must be transferred.
  5. Recapture with financial burden placed on transferee is applicable for tax credits under Section 45Q (Carbon Capture Sequestration Credit), Section 48 (Clean Electricity Investment Credit), Section 48C (Advanced Energy Project Credit), and Section 48E (Clean Electricity Investment Credit).
  6. Internal Revenue Code Section 6417.
  7. Tax Cuts and Jobs Act, PL 115-97, 131 Stat. 2054 (2017).

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