by Madeline M. Chiampou and Brian Levy
Last week, Sens. Chris Coons, D.-Del., and Jerry Moran, R.-Kan., introduced bipartisan legislation aimed at expanding the use of master limited partnerships (MLPs) from fossil fuel-based energy projects such as oil, natural gas, coal extraction and pipeline projects to also include renewable energy projects. Interests in MLPs are traded on markets, like corporate stock. However, unlike corporations, MLPs are not subject to entity level tax; rather, the profits of MLPs are subject to taxation at the partner level, much like other entities treated as partnerships for federal tax purposes. These benefits are viewed as having significantly increased investment in fossil fuel-based projects in the United States.
Congress first enacted tax legislation specifically relating to MLPs in 1987. The legislation required MLPs to derive at least 90 percent of their income (qualifying income) from certain categories of passive income, including income from resources subject to depletion, such as oil and gas. In 2008, the Emergency Economic Stabilization Act expanded the definition of qualifying income to include income from the transportation and storage of certain renewable and alternative fuels, such as ethanol, biodiesel and industrial-source carbon dioxide. The proposed legislation would expand the definition of qualifying income for MLP purposes to include income from wind, biomass, geothermal, solar, municipal solid waste, hydropower, marine and hydrokinetic, fuel cells and combined heat and power projects, as well as certain renewable transportation fuels.
Under the current legislative regime, developers and investors typically invest in renewable energy projects through entities taxed as partnerships for tax purposes. Tax benefits available to such projects flow through to and are allocated among the partners. MLPs would also permit tax benefits to flow through to and be allocated among the MLP partners. Thus, for federal income tax purposes, there would not be many differences between the traditional partnership scenario and MLPs. From a transaction cost perspective, both traditional renewable energy partnerships and MLPs can involve significant transaction costs to developers and investors. However, since MLP interests are able to be traded on a market, investing in or exiting from MLPs may be easier than selling non-MLP partnership interests in the private market. As a result, MLPs are more attractive for some private investors who are more accustomed to buying and selling shares of stock than investing in partnerships.
Most of the recent legislative focus from the renewable energy community has been on the impending expiration of tax credits related to the investment in and production of electricity through wind. Co-sponsor Coons has indicated that the proposed legislation should not be seen as a replacement to the expiring tax credits but as a complimentary piece of legislation. Without these tax credits or other tax incentives, the benefits of using MLPs alone may not be sufficient to make some renewable energy projects economically viable. However, it bears noting that any tax benefits generated by an MLP structure would be subject to existing limitations on the use of energy tax credits, such as the passive activity loss rules applicable to individuals and the investment tax credit and depreciation limitations related to ownership by tax-exempt entities. Although the MLP structure will be attractive to a larger range of investors, some of the limitations on the use of tax benefits may mean that the investor audience is still somewhat limited. Nevertheless, the MLP structure may be a beneficial option for renewable energy project investment, and, if tax credits or other benefits can be used by the MLP investors, renewable energy projects would be even more attractive investments.