By Max Riffin, Patrick Kealy, Adam Braillard, and Serge Béchade
On November 19, 2024, the Department of the Treasury and IRS issued final regulations that, for the first time, allow co-owners of unincorporated organizations such as partnerships to access clean energy tax credits through direct pay.
The new regulations build on the direct pay process introduced in 2022 by the Inflation Reduction Act (IRA). Prior to the IRA, many unincorporated organizations such as state and local governments, tribal entities, public school districts, rural electric co-ops, and tax-exempt organizations, were not able to benefit from clean energy tax credits because of their low or nonexistent federal tax liability. The IRA enabled these entities to access the full value of these clean energy tax credits by making the credits refundable though the direct pay process.
How May Partnerships Access Direct Pay? To access direct pay, a partnership must elect out of partnership tax treatment by making a Section 761(a) election. The new regulations modify the definition of partnerships eligible to make a Section 761(a) election to include partnerships organized exclusively to own and operate applicable credit property. This change effectively allows partnerships organized to develop a clean energy project to make the required elections and realize the associated tax benefits for their owners.
Which Partnerships Are Eligible to Make a Section 761(a) Election? For a partnership to be eligible to make a Section 761(a) election, each member of the partnership must be able to separately compute their income, and must reserve the right to take in kind or dispose of their pro rata share of any property produced, extracted, or used by the clean energy project, along with any associated clean energy tax credits. The members of the partnership are responsible for determining each respective member’s ownership interest in the partnership, and by extension, each member’s share of the clean energy project.
What is the Result of Electing Out of Partnership Status? A valid Section 761(a) election will result in each member of the partnership being treated as directly owning its proportionate share of the clean energy project. Importantly, partnerships that have made a valid Section 761(a) election do not allocate income, deductions, or credits for federal income tax purposes at the partnership entity level. Rather each member is treated as directly owning its proportionate share of the partnership’s assets, and each member becomes entitled to its pro rata shares of income, deductions, and clean energy tax credits for its respective share of the project, regardless of the approval of other members, in the same manner as if the members were co-owners in the underlying properties. Additionally, loans by a member of the partnership to the partnership would not be treated as a partnership liability, but rather a loan to each member of the partnership in proportion to the member’s ownership interest.
What is the Impact of the New Regulations on Partnership Owners? Now, co-owners of unincorporated organizations established as partnerships can benefit from accessing clean energy tax credits through the direct pay process. Importantly, partnerships themselves are generally ineligible for direct pay. However, under the new regulations, co-owners that are eligible can access direct pay for their pro rata share of the clean energy project they own by collectively electing out of partnership status. Co-owners that are ineligible for direct pay can also benefit by being able to transfer their share of the credits from the clean energy project.
More information regarding the new regulations can be found at: Federal Register: Election To Exclude Certain Unincorporated Organizations Owned by Applicable Entities From Application of the Rules on Partners and Partnerships. If you have any questions, please reach out to Max Riffin, Patrick Kealy, Adam Braillard, or Serge Béchade.