Since their implementation, transferable tax credits have been gaining traction as a strategic tool. It not only helps support economic and innovative development, but it also aids in building clean energy projects. As a taxpayer, you must be aware that when financial transactions are mingled with tax codes, there are strict and thorough audits. Whether you are a buyer, seller, or investor, ensuring robust due diligence and audit-readiness is the need of the hour.
In this article, we’ll help you understand some key elements of the audit and how you can prepare for this complex process.
Understanding Transferable Tax Credit Transactions
Transferable tax credits are credits earned by businesses or taxpayers for participating in policies encouraged by the government. However, with the new policy introduced in the Inflation Reduction Act of 2022, taxpayers can sell or transfer all or a portion of their tax credits to a third party for direct cash. This opens avenues for broader investors, large-scale productions, and improved liquidity. Be it §48, §45, and §45X, each type of tax credit requires proper due diligence and audit-preparedness to gain maximum benefit and floor the legal framework with clarity. It helps all involved parties – buyer, seller and government to stay in the loop with utmost transparency and safety.
In the complex landscape of transferable tax credits, ensuring due diligence and audit readiness is crucial for both buyers and sellers. Engaging in thorough documentation and maintaining transparent records are essential steps in this process. However, navigating these intricacies can be challenging without expert guidance. To streamline the process and mitigate potential risks, it is advisable to get reliable help from a tax consultant. Such professionals can provide invaluable insights and strategies tailored to your specific needs, ensuring compliance and optimizing the benefits of transferable tax credits. This proactive approach not only safeguards against potential audits but also enhances the overall efficiency of tax credit transactions.
Key Elements of Due Diligence
Following proper IRA guidelines will ensure that you are not subjected to regulatory fines or legal consequences. Here are some common elements of due diligence for your tax credits transfer:
Eligibility Criteria
At the center of every due diligence is ensuring that the transferable tax credits are legitimate and authentic. Buyers must verify that all the credits comply with the federal and state laws. Plus, check the legal validity of the sustainable energy project and other eligibility criteria. Here is the eligibility criteria for the 5 most popular transferable tax credits:
| Tax Credit | IRC Section | Eligible Projects/Activities |
| Investment Tax Credit (ITC) | §48 | Solar, battery storage, fuel cells, microgrids, EV charging, and interconnection property |
| Production Tax Credit (PTC) | §45 | Wind, biomass, geothermal, hydro, municipal solid waste, and solar (as an alternative to ITC) |
| Advanced Manufacturing Credit | §45X | Domestic production of solar modules, wind components, battery cells, and related clean tech |
| Carbon Capture & Sequestration Credit | §45Q | Carbon dioxide capture from power plants and industrial sources with geologic storage or reuse |
| Clean Hydrogen Production Credit | §45V | Low-emission hydrogen production using qualifying processes |
Some common important documents include:
- Tax credit certificates.
- IRS filings or allocation agreements.
- Project development and financing records.
- Certifications or approvals from relevant agencies.
Proper Documentation and Reporting
Establishing a clear chain of title is very important to maintain a sound origin record. Buyers must check and maintain whether the transferable tax credits have been previously transferred. This declares that the seller still has the legal rights to the credits. This includes ensuring compliance with any applicable holding periods or conditions. Following these will help prevent any future disputes regarding the ownership of the tax credit between transacting parties.
Financial Records and Fair Market Value
IRS mandates that the selling of the credits must be at a fair market price. This price is determined by the type, size, and current market value of the project. Plus, review the financial record of the credited amount, including calculations, credit valuation, project cost substantiation, and applicable tax rules.
How to Stay Prepared For Audits
The IRS and state tax auditors have the right to review your documents long after the transactions take place. These key tips will help you stay prepared for the audit:
Maintain a Comprehensive Audit File
Every party involved in the transaction should maintain an organized audit file that includes:
- The credit transfer agreement.
- Documentation of the credit-generating activity (construction costs, energy output, etc.)
- Correspondence with government agencies.
- Legal opinions and third-party verification reports.
- Tax filings and accounting records.
Engage Professional Advisers
The professionals with industry experience, such as law experts, tax advisors, and brokers, can ensure compliance and mitigate risk. They can point out potential red flags and holes that can prevent you from legal consequences and fines.
Transparency and Education
Maintain transparency among stakeholders, financial partners, and project owners to ensure smooth documentation at every step. You can offer regular updates or training to educate the people involved. Plus, creating a small internal team to monitor the process closely can streamline oversight and reduce administrative burden.
Conclusion
No matter the process or work, having detailed documentation and inspections will help create transparency in the long run. As a buyer, keep your eyes open to any financial discrepancy, failure of the legal framework, or improper documentation to ensure a seamless audit process. While it may seem pretty rigorous, following best practices and maintaining transparency will minimize the risk of tax and regulatory errors.
