The tax system shouldn't be used by lawmakers to provide social or economic benefits. Using the tax code to distribute benefits presents a barrier for recipients who lack the income and tax obligation required to qualify for a tax subsidy, in addition to the distortions that targeted tax deductions and credits can lead to.
Case studies include the Inflation Reduction Act (IRA), Creating Helpful Incentives to Produce Semiconductors (CHIPS), and the Science Act. Both statutes provide a plethora of tax credits, but they are only helpful to individuals who have substantial tax bills to offset. Since start-ups are not profitable, tax credits are not very helpful to them. Although it may take years, the tax rules does let start-ups to keep an unused tax credit on their books as an asset until the business is lucrative enough to use it. A future tax credit is also not much of an incentive right now.
The tens of thousands of organizations that do not pay income taxes, such as charities, nonprofit hospitals, universities, local governments, and quasi-public organizations like the Tennessee Valley Authority and rural electric companies, do not receive any encouragement from tax credits.
Two dubious workarounds are provided by the IRA and CHIPS Act: permitting taxpayers to sell or transfer their tax credits to other taxpayers and authorizing direct payments to untaxed entities in place of tax credits.
New IRS Guidance on Tax Credit Rules
The IRS has published guidance on the tax provisions of the IRA and CHIPS Acts, and it specifies that taxpayers may sell or transfer all or part of a tax credit to another taxpayer. The payment must be made in cash, and the transaction must be completed during the same calendar year that the credit is valid. Neither the buyer nor the seller will be allowed to deduct the amount from their taxes. In exchange, the buyer is permitted to deduct the full value of the credit in the applicable year, but is not permitted to resale the credit.The buyer, also referred to as the "transferee," must get appropriate documentation from the sellers to support the credit. The Joint Committee on Taxation (JCT) of Congress notes that the transferee may be subject to a 20 percent penalty in addition to the recapture of the credit and is responsible for any mistakes or "excessive" payments.
Untaxed commercial and governmental entities may choose to receive a direct payment equivalent to the value of the credit for each of the 12 available tax credits under the "elective pay" option. These include the alternative fuel vehicle refueling property credit, the carbon dioxide sequestration credit, the renewable electricity production credit, the alternative fuel vehicle refueling property credit, the zero-emission nuclear power production credit, the clean hydrogen production credit, the qualified commercial vehicle credit, the energy credit, the advanced energy project credit, the alternative fuel vehicle refueling property credit, the alternative fuel vehicle refueling property credit, the alternative fuel vehicle refueling property credit, the alternative fuel vehicle refueling property credit
Taxpayers who are businesses may sell or transfer the same credits.
Questionable Precedent for Transfers or Direct Payments
While many states permit the sale and transfer of business tax credits, such as net operating losses (NOLs) and clean energy incentives, according to JCT, very few federal energy-related tax credits had previously permitted transfers before the enactment of the IRA or CHIPS Act, and none had permitted direct payment or been in any other way refundable.Energy entrepreneurs have traditionally "monetized" their unused credits and deductions by establishing tax equity financing contracts with banks or investment companies that have a sizable tax burden. According to industry insiders, major corporations with tax liabilities between $50 million and $100 million are the ideal candidates for such agreements. Banks and investment companies can take on the unused tax credits and depreciation deductions associated with a wind farm or solar project in exchange for a term-limited equity part in the project.
Since tax credit sales don't require an equity partnership and are easier to set up, they might become more common than tax equity arrangements.
The American Recovery and Reinvestment Act of 2009 (ARRA) established the Section 1603 grant program, which allowed renewable energy companies to receive cash grants in lieu of investment and production tax credits for projects put in service before 2011. This type of financing dried up during the 2008 financial crisis. The awards for wind, solar, and other renewable energy projects were worth up to 30% of the overall cost.
The Section 1603 grant program ended at the end of 2011, but funds were still given out for projects that were finished in subsequent years. The program awarded more than $26 billion in grants to more than 100,000 projects during the course of its brief existence. The IRS was criticized by the Inspector General of the Internal Revenue Service for failing to implement an indication procedure to stop grantees of Section 1603 grants from also claiming investment tax credits. Similar worries about companies "double dipping" by applying for Section 1603 subsidies and Department of Energy loans for the same project were voiced by the Senate Finance Committee.
Newly Required Registration for Tax Credit Transfers and Sales
IRS advice now mandates that tax credit dealers and buyers register with the IRS in order to prevent the kind of mismanagement and misuse that were visible in the Section 1603 grant program. The registration is meant to serve as proof of the transaction and as a way to trace the transfer for future analysis.Only four workers were assigned by the IRS to oversee the Section 1603 funds, which drew criticism. The effectiveness of the new system will also depend on the IRS resources allocated to it. The mandatory reporting appears to be more focused on compliance than results, therefore it is unlikely that the information will give the IRS the information it needs to assess the effectiveness of green energy tax incentives.
$100 Worth of Tax Credits for Less Than $90 in Green Energy Investment
Because buyers can purchase $100 worth of tax credits at a price that experts suggest might vary from 6 to 15 percent, tax credit sales and transfers are a very ineffective way to finance green energy initiatives. In other words, the government essentially spends $100 to generate investments in renewable energy that are worth $85 to $94 each. After consulting firms and insurance companies, which broker and insure the transactions, incur their costs, the profits may even be lower.Additionally, compliance expenses are not included in the discounts; the Office of Management and Budget is currently trying to quantify them. According to the IRS, applying for direct payments will take 20,000 nonprofit organizations a total of 126,000 hours every year, and 50,000 taxpayers will spend a total of 308,000 hours doing so. These are probably understatements.
Tax Subsidies Create a Politically Fabricated Market
Tax equity finance for renewable energy projects was already a $18 to $20 billion per year sector before to the IRA and CHIPS Act. Firms that previously organized equity deals are coming in to broker renewable energy sales and transfers as a result of the IRA and CHIPS Act tax benefits. In order to cover the inherent risk in such transactions, insurance companies have joined the gold rush. Together with Ever.green, the consulting company Baker Tilly has developed a marketplace for sustainable energy tax credits that is akin to eBay.Such developments, according to others, show how the market may act to push funding toward renewable energy initiatives. But this market was manufactured by Washington legislators; it is not a naturally occurring market. The roughly a dozen clean energy sectors that would profit from these tax breaks were picked by lawmakers, not the market. The "monetization" business they gave rise to should be viewed through the same prism as the tax credits themselves, which contravene the fundamentals of wise tax policy.
Direct Pay: The EITC for Clean Energy
The second workaround, direct pay, is similar to how legislators give individual taxpayers social benefits like the Earned Income Tax Credit (EITC). Refundable tax payments have been the solution because many low-income taxpayers do not have enough income or tax liabilities to claim tax credits. Individuals cannot "monetize" or transfer their tax credits, though.The IRS has had difficulty running the refundable tax credit systems that are currently in place, which portends issues with the direct pay program. For instance, the IRS distributed approximately $33 billion in Additional Child Tax Credits (ACTCs) and over $57 billion in refundable EITCs in 2022. Paymentaccuracy.gov reports that the percentage of EITC overpayments was close to 32% while the rate of ACTC overpayments was close to 16%.
Now, the IRS must handle requests for direct payments from a variety of non-taxable organizations, educational institutions, and public bodies including local governments and the Tennessee Valley Authority. Although nonprofits are exempt from paying income taxes, they do file tax returns that may theoretically be connected to direct payments. However, a procedure for the countless untaxed entities that fail to file tax returns will need to be developed by the IRS.
The IRS is not prepared to act as a benefit delivery agency, thus the chances of mistakes and overpayments are certain to be considerable.
