The new Final Regulations released by the IRS give a way for Elective Payment Elections to open the door for tax-exempt entities to partner with taxable entities in innovative ways. This also allows for new funding opportunities for projects that generate tax credits. By opting out of Subchapter K and leveraging Section 6417, these organizations can monetize their credits, providing critical resources for renewable energy, infrastructure, and other community-focused initiatives.

On November 20, 2024, the U.S. Department of the Treasury and the Internal Revenue Service (IRS) unveiled a groundbreaking set of Final Regulations to enable certain tax-exempt entities to partner with taxable entities in innovative ways. These regulations, effective January 19, 2025, allow specific unincorporated organizations to opt out of the partnership tax rules under Subchapter K of the Internal Revenue Code (IRC). For organizations seeking to monetize their share of tax credits from qualifying properties, this represents an exciting new pathway.

What Are Elective Payment Elections?

Elective Payment Elections, introduced under Section 6417 of the Inflation Reduction Act in 2022, allow certain tax-exempt entities—referred to as applicable entities—to treat certain tax credits as payments against their income tax liabilities. These payments, equivalent to the value of the tax credits, can then be claimed as a refund.

Applicable entities eligible for Elective Payment Elections include:

• Tax-exempt organizations.
• State and local governments.
• The District of Columbia.
• Native American tribal governments.
• Alaska Native corporations.
• The Tennessee Valley Authority.
• Rural electric cooperatives.
• Certain agencies and instrumentalities of the above entities.

While partnerships are generally excluded from making Elective Payment Elections, the Final Regulations provide a pathway for tax-exempt entities co-owning tax-credit-generating properties with taxable entities to participate.

The Role of Section 761(a): Opting Out of Subchapter K

At the heart of these new regulations is Section 761(a) of the IRC, which allows unincorporated organizations to elect out of partnership tax rules if certain conditions are met. By doing so, members of the organization are treated as co-owners of the property, rather than partners in a partnership.

The Final Regulations expand eligibility for Section 761(a) elections, enabling tax-exempt entities to fully utilize their proportionate share of tax credits.

Key Conditions for Opting Out

To qualify for a Section 761(a) election, an unincorporated organization must meet these requirements:

1. Ownership Structure: The organization must be wholly or partially owned by one or more applicable entities.
2. Joint Operating Agreement: Members must have a formal agreement that:

• Grants members the right to take in kind or dispose of their share of the property and associated tax credits.
• Restricts the organization to owning and operating applicable credit properties.

1. Purpose: The organization must exist solely to own and operate properties eligible for tax credits.
2. Income Determination: Members must be able to calculate their share of income without requiring the computation of partnership taxable income.
3. Legal Entity Restrictions: The organization cannot be treated as a corporation or an association for tax purposes.

Who Can Benefit from These Regulations?

These changes are particularly beneficial for tax-exempt entities looking to monetize their tax credits. Examples include:

• Municipalities investing in renewable energy projects.
• Nonprofits co-owning solar farms with private investors.
• Tribal governments developing energy-efficient housing projects.

By opting out of Subchapter K, these entities can treat their share of the tax-credit-generating property as directly owned, enabling them to make Elective Payment Elections for their portion of the credits.

Broader Scope and Simplified Co-Ownership Rules

The Final Regulations address key challenges and expand the reach of Section 761(a):

1. Expanded Eligibility: Previously, only organizations producing electricity from applicable credit properties could elect out. Now, organizations engaged in joint production, extraction, or use of any qualifying property can participate.
2. Simplified Ownership Structures: Co-owners can now hold applicable credit property through a legal entity, provided it is not treated as a corporation.
3. Agent Delegation Flexibility: Participants can delegate certain marketing activities to agents, including long-term contracts for selling property produced, as long as the delegation is limited to a one-year term.

Practical Considerations for Tax-Exempt Entities

Tax-exempt entities must carefully navigate the new regulations to maximize benefits. Key steps include:

1. Understand the Election Process

Making a Section 761(a) election requires filing a statement with the organization’s partnership return (Form 1065). This statement must include:

• The organization’s name, address, and identification details.
• A declaration of eligibility under Treasury Regulations Section 1.761-2.
• Access to the joint operating agreement or information about its details if the agreement is oral.

2. Monitor Ownership Changes

A Section 761(a) election terminates if a “terminating transaction” occurs, such as the sale of an interest in the organization. Careful tracking of ownership changes is crucial to maintaining the election.

3. Address Reporting and Withholding Obligations

The Final Regulations introduce detailed reporting requirements for entities making Elective Payment Elections. Tax-exempt entities must ensure compliance with these obligations.

4. Avoid Prohibited Structures

Partnership flip structures—where allocations of income or credits change over time—are explicitly prohibited. Tax-exempt entities must design their ownership arrangements to comply with statutory requirements.

Example: How It Works in Practice

Scenario: A rural electric cooperative (a tax-exempt entity) and a private investor jointly own a wind farm generating renewable energy tax credits.

• The cooperative and investor form an unincorporated organization with a joint operating agreement.
• The cooperative elects to opt out of Subchapter K under Section 761(a), making it a direct owner of its share of the wind farm.
• The cooperative makes an Elective Payment Election under Section 6417, receiving a refundable tax payment for its portion of the credits.

This arrangement allows the cooperative to monetize its tax credits efficiently while maintaining compliance with IRS rules.

Looking Ahead: Proposed Regulations on Direct Pay

Alongside the Final Regulations, the Treasury and IRS released Proposed Regulations that outline administrative requirements for making Elective Payment Elections. These include:

• Specific information to include in the Section 761(a) election statement.
• Procedures for revoking elections via private letter rulings.
• Rules governing “terminating transactions” and their impact on elections.

And note that these Proposed Regulations also clarify that any request to revoke a Section 761(a) election must be made by submitting a private letter ruling request. While these Proposed Regulations are not yet final, they provide a roadmap for how the elective payment process will work in practice.