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Recent Treasury Regulations Provide Flexibility When Monetizing Renewable Energy Tax Credits

Content by Chris Tassone; Justin Cook; David Bartoletti; Javan Kline
Treasury
November 25, 2024

The Treasury Department finalized regulations allowing for certain unincorporated organizations making investments in certain clean energy technologies to opt out of partnership treatment for federal income tax purposes by making an election under section 761(a) of the Internal Revenue Code (“IRC”). These rules create flexibility for members / owners of unincorporated organizations (e.g., LLCs, state law partnerships) when they are seeking to monetize tax credits generated by their investment in renewable energy generation. By electing out of partnership treatment, members that are “applicable entities” (e.g., tax-exempt organizations, state and local governments)[1] are able to receive a direct payment for their portion of a credit under IRC 6417. Meanwhile, members that are taxable entities (i.e., not applicable entities) remain eligible to claim their respective portion of a credit and/or make a transfer under IRC 6418.

Background

Two of the signature changes from the Inflation Reduction Act (“IRA”) were to (1) allow certain applicable entities to claim tax credits by direct payment[2] and (2) allow taxpayers to transfer credits to unrelated third parties.[3] The IRA also prohibited partnerships from claiming credits by direct payment, unless the direct payment was made with respect to certain special credit provisions – IRC §§ 45Q, 45V, and 45X.[4]

The IRA did not directly address whether an applicable entity that is a partial member or owner of a renewable energy project could make a direct payment election with respect to its proportionate investment. The Final Regulations to IRC § 761 address this question, and they provide taxpayers and applicable entities flexibility in monetizing the credit amount.

New Final Rules

Pursuant to the final version of Treas. Reg. § 1.761–2(a)(4), unincorporated organizations seeking to opt out of partnership treatment must meet all of the following requirements:

  1. The entity is owned, in whole or in part, by one or more applicable entities.[5]
  2. The members of the entity enter into an operating agreement in which the members reserve the right to take in kind or dispose of their pro rata shares of property produced, extracted, or used and any associated renewable energy credits or similar credits.
  3. The entity is bound by its operating agreement to exclusively own and operate applicable credit property.[6]
  4. One or more of the applicable entities will make an elective payment election (direct payment election) for the applicable credits determined with respect to its share of the applicable credit property.
  5. The members of the entity are able to compute their income without the necessity of computing partnership taxable income.
  6. The entity is not a syndicate, group, pool, or joint venture which is classifiable as an association, or any group operating under an agreement which creates an organization classifiable as an association.

Entities seeking to make this election must do so on a statement attached to, or incorporated in, a properly executed partnership return, Form 1065.[7] The return must be made by the due date for the partnership return for the first taxable year for which the exclusion from subchapter K is desired.[8]

Implications

There has been increasing interest in the use of public-private partnerships (P3s) and alternative structures when financing large-scale energy projects. These final rules provide welcome certainty for unincorporated organizations looking to monetize a portion of their credit through direct payment.

Making an IRC § 761(a) election carries benefits and drawbacks. On the one hand, an IRC § 761(a) election allows for the applicable entity to monetize their investment by direct payment. On the other hand, any entity making an IRC § 761(a) election must comply with the requirements set forth in Treas. Reg. § 1.761-2(a)(3) and outlined above. For example, an unincorporated organization that has made a valid IRC § 761(a) election is not subject to IRC § 704, which provides rules for determining a partner’s distributive share of a partnership’s tax items. Any agreement among members to specially allocate depreciation deductions under the rules of subchapter K would make the organization ineligible for an IRC § 761(a) election. Advisors and project owners should consider the costs and benefits of making an IRC § 761(a) election to opt out of partnership treatment.

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[1] Pursuant to IRC § 6417(d)(1)(A), the term “applicable entity” means—

  • any organization exempt from the tax imposed by subtitle A,
  • any State or political subdivision thereof,
  • the Tennessee Valley Authority,
  • an Indian tribal government (as defined in section 30D(g)(9)),
  • any Alaska Native Corporation (as defined in section 3 of the Alaska Native Claims Settlement Act (43 U.S.C. 1602(m)), or
  • any corporation operating on a cooperative basis which is engaged in furnishing electric energy to persons in rural areas.

[2] See IRC § 6417.

[3] See IRC § 6418.

[4] Treas. Reg. § 1.6417-2(a)(1)(iv). See also Treas. Reg. § 1.6417-1(g).

[5] See IRC § 6417(d)(1)(A) and Treas Reg. § 1.6417-1(c).

[6] See Treas. Reg. § 1.6417-1(e).

[7] Treas. Reg. § 1.761–2(b)(2).

[8] Treas. Reg. § 1.761–2(b)(1).