New audit rules for partnerships, referred to as the Centralized Audit Regime (CAR), are now in place and likely to affect partnership agreements for renewable energy projects.
Most IRC Section 48 investment tax credit (ITC) projects utilizing solar energy equipment and Section 45 production tax credit (PTC) projects, such as open- and closed-looped biomass, geothermal, wind, and hydropower electricity producing facilities, are structured around partnership flips, inverted leases (or lease pass-throughs), or sale leasebacks. These structures usually require the use of a partnership, and even multiple tiers of partnerships, to pass cash flow and tax benefits to investors with an appetite to monetize benefits.
In most cases, the partnership’s operating agreement will need to be amended to conform with CAR. With the new rules, there are a few points that may require particular attention.
Under the new rules, a partnership is now required to have a partnership representative (PR), which has broad powers including the sole authority to bind the partnership and all partners with respect to any proceeding under CAR.
A renewable energy project partnership is typically structured and modeled to achieve very specific economic results for different investors. It often relies on minimum levels of capital investment and special allocations of profit losses, credits, and liabilities that result in the investor yields being very sensitive to deviations.
In some cases, the sponsor investor acts as the PR and may have greater exposure to adjustments that result in yield distortions from the base case model. This can also happen because of preferences of the tax equity investor.
Due to the sensitivities to yield distortion from the base case model, tax equity investors will want to have some say or direction in what agreements or elections the PR can make on their behalf. On the other hand, because of the potentially increased exposure to the PR, the sponsor investor may want some indemnification protection for decisions they’re required to make.
For example, a tax equity investor would likely frown on a PR making a pull-in election, as outlined below, when a push-out election would have been more favorable.
Audit Adjustment Elections
If the partnership failed to make the proper elections as permitted under the new rules and the IRS were to examine their tax returns and find adjustments, rather than simply passing along the adjustments and the resulting tax obligations to each member, the IRS can instead assess the tax to the partnership at the highest marginal rates.
This would create burdensome tax payment and tax collection obligations to the partnership and these obligations may also need to be reflected in the financial statements of the partnership.
Instead of tax assessment at the partnership level, partnerships have two additional options for satisfying audit adjustments.
The partnership may elect to push out audit adjustments to its reviewed-year partners within 45 days of issuance of a notice of final partnership adjustment (NFPA). Reviewed-year partners then report the audit adjustments on their tax returns for the tax year in which the NFPA is issued.
The underpayment interest rate on these adjustments increases by 2% when utilizing this election.
Most renewable energy partnerships will likely opt to use the push-out election should an adjustment be necessary.
The reviewed-year partners pay the tax due under an amended tax return filing procedure without actually filing amended returns. The partnership is able to reduce its imputed underpayment by the amounts the partners paid.
A partnership with 100 or fewer eligible partners may elect to opt out of CAR. While most renewable energy projects have fewer than 10 partners, opting out isn’t an option if even one partner is itself a partnership, trust, or disregarded entity.
Although an opt-out election may seem like the best option if available, some partners may actually prefer that the partnership not opt out of CAR, fearing that by doing so the IRS could conceivably expand an audit to the partners.
While your partnership’s attorney ultimately will need to either draft or amend the operating agreement, he or she may not necessarily have in-depth partnership tax experience or be aware of the CAR rule changes. To move forward, consider taking these first steps:
- Revisit existing partnership agreement
- Review and understand new CAR rules
- Speak to your attorneys and accountants to make appropriate amendments and elections
- Define duties and responsibilities of the PR
Although the CAR rules are effective as of January 1, 2018, generally, taxpayers have until the original due date for their 2018 tax returns to amend their partnership’s operating agreements to account for the new rules. For calendar-year partnerships, this is March 15, 2019.
Find a more in-depth review of the new CAR rules in this article.
We’re Here to Help
To learn more about the implications of these new audit rules for your renewable energy projects and how you and your legal advisors can evaluate potential changes to your operating agreement, contact your Moss Adams professional.