Tax Optimization: Using Tax Credits for your benefit

Taxpayers often overlook the usage of federal tax credits to generate additional income. Two types of tax credits stand out in particular – Investment Tax Credits (“ITC”) and Production Tax Credits (“PTC”).

The Investment Tax Credit, as per Internal Revenue Code (IRC) Section 48, allows taxpayers to receive a credit for investment in specified property used in a trade or business. The percentage of the credit varies depending on the type of property, typically ranging from 10-30% of the investment made. These credits can be used to offset the taxpayer’s federal income tax liability, or, in some cases, they can be carried back to a prior tax year or forward to future tax years, thereby generating income in the form of tax savings.

On the other hand, the Production Tax Credit, as per IRC Section 45, is a per-kilowatt-hour tax credit for electricity generated by qualified energy resources and sold by the taxpayer to an unrelated person during the taxable year. The amount of credit depends on the type of resource and the date the facility was put into service. Once again, these credits can be used to reduce federal income tax liability, with any excess potentially being carried forward for up to 20 years.

As lucrative as these tax credits can be, they can be particularly beneficial to taxpayers who are unable to utilize the full amount of credits available to them due to limited tax liability. This is where the option to ‘sell’ or ‘transfer’ these credits becomes vital. While the IRC does not explicitly provide for the sale of tax credits, taxpayers can effectively transfer these credits by entering into partnerships or other transactional arrangements.

One common approach is to form a partnership with a ‘tax equity’ investor. In such a partnership, the taxpayer (who is typically a project sponsor) contributes assets that are eligible for tax credits, while the tax equity investor contributes cash. The partnership agreement provides for the allocation of the tax credits to the tax equity investor, thereby allowing the investor to offset their tax liability and the taxpayer to monetize the credits.

Another method to monetize these credits is through sale-leaseback transactions. In these arrangements, the taxpayer sells property eligible for tax credits to a party who can utilize them, and then leases back the property. The purchaser effectively gets the property and the tax credits, while the taxpayer gets cash and continued use of the property.

Both strategies require careful structuring to ensure compliance with complex federal tax rules, such as those pertaining to partnership allocations under IRC Section 704 and lease inclusion amounts under IRC Section 467. Thus, the assistance of experienced tax counsel is essential.

In conclusion, the savvy use of federal tax credits, whether through direct utilization or through strategic transactions, can be a significant tool for wealth generation. It’s not just about earning income; it’s also about smartly maximizing the potential of every dollar invested or generated. As always, seek professional advice to navigate these opportunities efficiently. Feel free to reach out to Burrell Law and speak to one of our attorneys.