Federal income tax treatment of certain transferable state tax credits.

• Author: Smith, Annette B.
• Position: Massachusetts

Taxpayers may receive state tax credits that for various reasons they are unable to use. These taxpayers often seek to sell their unwanted credits at a discount to generate additional cash and avoid losing the entire benefit of those credits. While in the past it has been somewhat difficult for motivated sellers to find interested buyers, the emergence of online marketplaces and auction houses has provided a single point of contact for both sellers and buyers, making sales and purchases of transferable state tax credits more common.

As a result, the IRS and the courts have begun to consider some of the federal income tax consequences associated with these transactions. In CCA 201147024, the IRS Office of Chief Counsel addressed the federal income tax treatment of certain transferable Massachusetts state tax credits.

Massachusetts Credits

Massachusetts offers a number of taxpayer incentives as a part of its economic development program. Some of these incentives are in the form of nonrefundable tax credits, including the brownfields tax credit, the motion picture tax credit (partially refundable), the historic rehabilitation tax credit, the low-income housing tax credit, and the medical device tax credit. Each credit is transferable in accordance with Massachusetts state law.

Issues Addressed in CCA 201147024

Is the original receipt of the state tax credit a taxable event? While gross income generally includes income from all sources, the IRS explained that the original recpient of the state tax credit "is not viewed as having received property in a transaction that results in the realization of gross income." Stated differently, the granting of the credit is not treated as equivalent to a payment of cash or other property, and the amount of the credit is not included in gross income under Sec. 61. Under the CCA, the credit is treated as a potential reduction in the state tax liability. As a result, the federal income tax effect of such a credit normally is to reduce any deduction for payment of state tax that otherwise may have been available under Sec. 164(a).

What is the basis of the state tax credit to the original recipient? Sec. 1012 generally provides that the tax basis of property is the cost of the property. Regs. Sec. 1.1012-1(a) defines "cost" as the amount paid for the property in cash or other property. Since the state tax credit is obtained by complying with state law and is not acquired by purchase, the CCA concludes that the...