Partnerships and S corporations are now subject to new regulations when transferring certain clean energy tax credits under Section 6418 of the tax code. Nevertheless, these entities remain advantageous for effective tax-planning, especially in regards to buying and selling energy tax credits.
These entities offer clear tax benefits primarily for clean energy projects and energy tax credit planning:
- Tax credits can flow directly to partners instead of being held at the C corporation level.
- Special allocations of tax depreciation and tax credits.
- Partners are only subjected to a single layer of taxation.
The final regulations, published on April 25, allow partnerships to transfer their tax credits for investment or production to an unrelated third party. They can also purchase these credits under the new rules, which explores election to transfer credits, eligible credit amounts, treatment of income from credit sales and the allocation of tax-exempt income.
Despite potential complications, there’s positive news for partnerships and S corporations. If a partnership includes a tax-exempt partner and has not elected to be treated as an applicable entity under Section 6417 (in regard to 45Q, 45V, and 45X credits), the final regulations permit the partnership to elect to make a tax credit transfer under Section 6418.
These developments avoid potential issues wherein the IRS might have ruled that a partnership with a tax-exempt partner was “tainted” and treated as a tax-exempt entity for the purpose of tax credit transfer rules. These tax-exempt entities are prohibited from transferring tax credits under Section 6418.
The finalised rules also allow income received from the sale of tax credits to be treated as tax-exempt for the partners within the partnership. The IRS and Treasury have confirmed there should be no taxable income for sellers of these tax credits and no deductions for the buyers. While not without caveats, the benefits make partnerships a worthwhile option for energy projects.
Several taxpayers argued that the passive income rules should not be applied to a partnership that acquires these tax credits. However, the IRS and Treasury have not provided an allowance from the material participation rules in the final regulations, which a transferee partnership must consider in how the rules under Section 469 affect the operation of the transferred credits.
Partnerships have long served as an effective tool in tax planning for clean energy projects. And while new rules introduce additional challenges to navigate, such as passive activity rules and at-risk disclosure requirements, partnerships maintain their standing as a valuable tool for energy tax credits.
This exciting development in the field of energy tax credit transfers demonstrates the ever-evolving landscape of financial regulation and the considerable role these partnerships play in clean energy projects.