Treasury Energy Credit Rules Are a Small Win for Partnerships

Partnerships and S corporations now must follow special rules when transferring certain clean energy tax credits under Section 6418 of the tax code. Regardless of potential complications, these flow-through entities still are an effective vehicle in tax-planning for buying and selling energy tax credits.

Partnerships provide clear tax advantages for clean energy projects and energy tax credit planning, including:

• Tax credits allowed to flow directly to partners versus being held at C corporation level
• Special allocations of tax depreciation and tax credits
• Single layer of taxation for partners

The final regulations released April 25 allow partnerships to transfer their tax credits for investment or production to an unrelated third party. They also can purchase these credits under the new rules, which address election to transfer credits, eligible credit amounts, treatment of income from credit sales, and allocation of tax-exempt income.

There is some good news for partnerships and S corps. If a partnership includes a tax-exempt partner and the partnership hasn’t elected to be treated as an applicable entity under Section 6417 (relating to 45Q, 45V, and 45X credits), the final regulations allow the partnership to elect to make a tax credit transfer under Section 6418.

There was a possibility the IRS might rule a partnership was “tainted” when the partnership included a tax-exempt partner, meaning it would have been treated as a tax-exempt entity for purposes of tax credit transfer rules. Tax-exempt entities aren’t allowed to transfer tax credits under Section 6418.

The final rules also allow cash received from selling these tax credits to be treated as tax-exempt income to the partners in the partnership. The IRS and Treasury maintain there should be no taxable income for sellers of these tax credits and no deductions for buyers.

This treatment is another reason partnerships might be a good option for energy projects. The buying and selling of tax credits won’t result in additional tax for the seller or a tax deduction for the payment by the buyer, which includes partners in a partnership.

The rules generally state that the allocation of tax-exempt income be determined based on each partner’s distributive share of the eligible credit, but it also provides for some flexibility in a manner outlined in the partnership agreement. This rule is beneficial for partnerships because it allows for special allocations of income and deductions according to each partner’s agreed-to terms in the partnership agreement.

The key here is flexibility. By using a partnership entity for investing in energy projects and tax credits, the partners have flexibility to allocate tax income, credits, and deductions according to their needs.

The final regulations require a transferor partnership must request from its partners information necessary to determine if the credit would be limited under Section 49 and to disclose that limitation in the tax return for which the eligible investment property is placed in service. This requirement can complicate the process associated with transfer of eligible credits.

Application of Section 49 at-risk rules—and disclosure of each individual’s nonqualified, nonrecourse financing with respect to the investment tax credit property—needs more information gathering and disclosure by the partnership that wishes to transfer the energy tax credits. This complicates and potentially delays any tax credit transfer by a partnership.

The new rules also have some less-than-optimal news for partnerships. The IRS received several comments from taxpayers arguing that the passive income rules shouldn’t apply to a partnership that acquires these tax credits. The IRS and Treasury didn’t provide a carve-out from the material participation rules in the final regulations, so a transferee partnership must determine how the rules under Section 469 affect the use of the transferred credits.

Applying the passive activity rules to individuals (including individual partners in a partnership) could significantly limit the market of potential buyers of energy tax credits to C corporations. Most individuals wouldn’t meet the active participation requirements, which would limit their ability to use the energy tax credit as it will only offset their passive income.

Under the final regulations, any tax-exempt income resulting from the receipt of consideration for the transfer of a tax credit portion by a transferor partnership (or S corporation) is treated as arising from an investment activity—not from the conduct of a trade or business within the meaning of Section 469(c)(1)(A).

As such, any tax-exempt income is not treated as passive income to any direct or indirect partners or shareholders who do not materially participate within the meaning of Section 469(c)(1)(B). Generally, this would eliminate a partner’s ability to offset passive losses with the tax-exempt income from the sale of the credits, further reducing the benefits from the sale of the eligible credits. This might not have a significant impact on the overall decision to sell credits but should be considered in the analysis.

Looking Ahead

Partnerships long have been an effective tool in tax planning for clean energy projects. They provide a flow-through of tax credits to their partners and the ability to specially allocate tax depreciation and tax basis.

The new credit monetization rules haven’t changed these tax advantages for using partnerships and potentially have expanded the appeal of using a partnership structure to purchase credits. Although there might be additional challenges to navigate, including the passive activity rules and the at-risk disclosure requirements, partnerships still are an effective tool for energy tax credits.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Devin Hall is tax partner with Crowe, where he leads the firm’s energy practice.

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