In tax credit transactions, eligibility risk refers to the risk that the IRS disallows a claimed tax credit because the underlying project doesn't meet statutory or regulatory requirements. This installment of Crux's series on underwriting risks will go into detail on eligibility risk: what it is, how it arises, and how tax credit buyers and investors manage it through targeted diligence and contractual protections.
For more information on other types of tax credit transaction risks, see our overview “Tax credit transaction risks: An introduction for corporate taxpayers” and our additional articles on recapture risk and basis risk.
Key takeaways
Every tax credit transaction should begin with a foundational question: “Does the project I am evaluating actually qualify for the credit being sold, in the amount being sold?” Eligibility risk (sometimes called “qualification risk”) refers to the risk that a project does not meet the requirements of a specified tax credit, resulting in an IRS disallowance of the tax credit. Eligibility risk matters for tax credit buyers and investors because the transferee taxpayer — i.e., the buyer or investor — is the taxpayer utilizing the credits. If the IRS determines that the credits were not valid, that liability flows directly to the buyer (though this exposure is mitigated by seller indemnification and insurance as discussed below).
Eligibility risk is distinct from recapture risk: Recapture risk addresses whether a validly claimed credit ceases to meet the statutory requirements for that credit during its recapture period; eligibility risk addresses whether a tax credit was valid to begin with. Notably, recapture risk only applies to ITCs, whereas eligibility risk applies to both ITCs and PTCs.
Eligibility risk varies by credit type. ITC eligibility is evaluated at a point in time — when the project is "placed in service" — while PTC eligibility is based on verified outputs (such as electricity or eligible components) over the credit period.
For both credit types, any bonus adders claimed — including prevailing wage and apprenticeship (PWA), domestic content, and energy community adders — introduce an additional layer of qualification requirements that the project must meet.
To qualify for the §48 or §48E ITC, projects must demonstrate that:
For §48E credits specifically, the facility must also demonstrate a greenhouse gas emissions rate not greater than zero.
The placed-in-service determination tends to be the most fact-intensive and receives the most attention in the diligence process. Because placed-in-service timing determines the tax year in which the credit is claimed and the start of the recapture period, small discrepancies can have material consequences.
The IRS generally considers multiple factors to determine when a power project is placed in service, including:
Advisors often also rely on utility-issued permission-to-operate (PTO) letters to establish the placed-in-service date and provide evidence the project has met these criteria.
For PTCs, qualification is tied to performance. The project must actually produce, and in most cases sell to an unrelated party, eligible energy, fuels, or components over time. Diligence focuses on verifying ongoing output or production volumes underlying the credit.
For §45 and §45Y electricity-generation PTCs, qualification requires that:
For §45X advanced manufacturing credits, qualification is per unit — each eligible component must meet statutory specifications including being produced by the taxpayer in the U.S. and sold to an unrelated party.
For §45Z clean fuel credits, qualification hinges on the fuel's lifecycle emissions rate — typically determined using the US Department of Energy's (DOE) 45ZCF-GREET model.
Other transferable PTCs, including §45U zero-emission nuclear credits and §45Q carbon oxide sequestration credits, carry their own specific qualification criteria that buyers should evaluate against the relevant statutory and regulatory frameworks.
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Bonus adders can substantially increase the value of a credit, but they also introduce additional qualification requirements that buyers and investors should evaluate along with the legitimacy of the base credit.
The prevailing wage and apprenticeship requirements, which if met increase the base ITC or PTC by a factor of five, warrant close diligence attention given its magnitude and the ongoing nature of the requirements through the recapture period (for ITCs) and the full credit period (for PTCs).
The domestic content, energy community, and low-income community adders each carry their own eligibility requirements and should receive diligence attention to confirm that the project meets the specific statutory and regulatory criteria for each adder claimed.
The OBBB introduced new prohibited foreign entity restrictions that serve as eligibility requirements for a set of transferable tax credits, including §48E, §45Y, §45X, §45U, §45Z, and §45Q credits. Projects with certain ownership, financing, or material assistance from PFEs exceeding defined thresholds may be disqualified from credits altogether.
While final guidance related to PFE restrictions is forthcoming, market participants are adjusting their eligibility risk diligence processes to incorporate these new restrictions, and buyers should expect to see supplier attestations, ownership representations, and material assistance cost ratio calculations as part of the diligence package for applicable credits.
Because eligibility challenges flow directly to the taxpayer claiming the tax credit, buyers, investors, and their advisors employ a combination of diligence, contractual protections, and tax credit insurance to evaluate and mitigate eligibility risk.
Buyers, investors, and their advisors conduct a detailed review of the documentation substantiating a project's eligibility for the claimed credit and any bonus adders. Key areas of focus include:
Buyers and investors typically negotiate indemnification provisions requiring the seller to make them whole if the IRS determines their credits are ineligible. Tax credit transfer agreements may also include "no-fault" indemnity provisions, meaning the buyer is entitled to be made whole for any reduction in credit value — even if the loss does not result from a breach of the seller's representations.
In some cases, transactions will include a parent guarantee on the seller’s indemnity to provide additional security, particularly when the seller lacks sufficient creditworthiness.
Many buyers and investors procure tax credit insurance to protect against eligibility-related losses. Policy terms are bespoke, and buyers should pay close attention to both how covered tax treatment, knowledge qualifiers, and exclusions are drafted and how the policy interacts with the seller's indemnity under the tax credit transfer agreement.
For more information, see Crux's comprehensive Guide to the Tax Credit Insurance Market.
Eligibility risk exists in every tax credit transaction, but market participants have developed thorough standards and practices to move transactions forward. Our team of finance and tax specialists helps buyers and investors understand what is standard for the market in terms of risk and pricing, drawing on benchmarks developed from our $55 billion transaction dataset. Crux provides comprehensive diligence support, in close collaboration with legal counsel, accounting firms, and insurance advisors to help buyers put protections in place to transact with confidence.
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