Transferable Tax Credits and the Excess Credit Penalty: The Buyer Risk That Diligence Is Built to Prevent
Most buyers enter the transferable tax credits market focused on one number: the discount. How many cents on the dollar can they acquire a credit for? But there is a second number that matters far more, and most first-time buyers do not think about it until their tax counsel brings it up. That number is 120%.
That means the buyer’s tax can be increased by the excessive credit amount plus a 20% addition to tax. The excess amount gets added back to the buyer’s tax liability, plus a 20% penalty on top of it. And here is the part that tends to change the conversation: the seller does not owe that penalty. The buyer does.
How the Excess Credit Penalty Actually Works
Under Section 6418(g)(2) of the Internal Revenue Code, an excessive credit transfer occurs when the amount of credit a buyer claims on their return exceeds the amount that would have been properly allowable to the seller. The math is straightforward, but the consequences are not.
When the IRS flags an excessive credit transfer, the buyer’s tax for that year increases by the full excess amount. Then a 20% penalty stacks on top. So if a buyer claims $10 million in transferable tax credits and the IRS later determines that only $8 million was legitimately generated, the buyer owes the $2 million excess plus a $400,000 penalty. That is $2.4 million in exposure from a deal the buyer probably thought was clean.
The only way to avoid that 20% surcharge is to demonstrate reasonable cause.
What “Reasonable Cause” Actually Requires
Reasonable cause is not a vague concept here. The final regulations under Section 6418, published in 2024, spell out specific circumstances the IRS will consider. And the single most important factor, per the regulatory text itself, is the extent of the buyer’s efforts to verify that the credit amount being transferred matches what was actually allowable.
That means passive reliance on the seller’s representations does not cut it. The IRS has been explicit on this point. Buyers need independent verification.
Circumstances that may support a reasonable cause defense include reviewing the seller’s records related to credit determination, reasonably relying on third-party expert reports, and reviewing the seller’s audited financial statements. The regulations frame this as a facts-and-circumstances test, but the direction is clear. Buyers who do their homework get protection. Buyers who take the seller’s word for it do not.
Why the Risk Falls Entirely on the Buyer
This is the structural asymmetry that defines the transferable tax credits market. The seller generates the credit. The seller controls the project, the documentation, the labor compliance, the eligible basis calculations. But once the transfer election is made, the buyer carries the liability if any of that turns out to be wrong.
Credit eligibility depends almost entirely on the seller’s activities, yet the buyer is the one who faces the excessive credit transfer tax. That mismatch is not a flaw in the system. It is a deliberate design choice by Treasury and the IRS to incentivize buyer diligence. And it works, because serious buyers now treat due diligence not as a formality but as their primary risk management tool.
The areas that create the most exposure tend to be prevailing wage and apprenticeship noncompliance, domestic content shortfalls, and miscalculated eligible basis. Each of these can quietly shrink the allowable credit below what was originally represented, triggering the excess credit penalty for the buyer who already wired the cash.
How Buyers Protect Themselves in Practice
Smart buyers build their protection in layers. The diligence process typically starts with an independent review of the project’s credit calculation, including eligible basis, bonus credit qualifiers, and compliance documentation.
Beyond diligence, contractual protections matter. Most transfer agreements include seller indemnification provisions that require the seller to make the buyer whole if the credit gets partially or fully disallowed. Post-closing covenants obligate the seller to maintain ongoing compliance and notify the buyer of any recapture events.
Tax credit insurance has also become a common and growing feature, particularly for larger deals where the excess credit exposure runs into the tens of millions. A comprehensive guide to transferable tax credits can walk buyers through how these protections fit together.
Conclusion
The excess credit penalty is not some theoretical risk buried in regulatory fine print. It is a 120% exposure that lands squarely on the buyer, and it is the reason every serious transferable tax credits transaction starts with diligence, not a term sheet. Buyers who understand this build their deals around it. The ones who do not find out the hard way that a good discount means nothing if the credit behind it was never fully there.
