GAAP Accounting for Tax Equity Investments in Partnerships and LLCs

• Date: 01 July 2016
• DOI: http://doi.org/10.1002/jcaf.22173
• Author: George L. Strobel
• Published date: 01 July 2016

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© 2016 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22173

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GAAP Accounting for Tax

Equity Investments in

Partnerships and LLCs

George L. Strobel II

There is wide-

spread and

growing use of

federal tax credits as

a means for compa-

nies to reduce their

effective tax rates

without resorting

to offshore head-

quarters and more

exotic tax planning.

Banks have long

invested in projects

qualifying for federal

low-income housing

credits as a cost effective means

of meeting their Community

Reinvestment Act require-

ments. Now, however, a variety

of publicly traded corporations

invest each year in projects

generating federal historic tax

credits and/or renewable energy

sourced investment tax credits.

There has also been widespread

investing by insurance compa-

nies in state tax credits that can

be used to offset their state pre-

mium tax liabilities.

Typically, these credits

are incentives provided by

government to support socially

desirable economic activity.

The generators of these credits

often cannot use the credits

themselves, either because they

don’t have taxable incomes or

they already have too many

credits. So they seek tax equity

investors who want the credits

as a means of monetizing the

credits they receive from these

socially desirable activities. The

capital contributions made by

the tax equity investors nor-

mally results in reducing the

amount of borrowing that the

project sponsor is

required to incur in

order to complete the

project.

Federal tax credit

investments are all

made through the

use of partnerships

or LLCs that are

taxable as partner-

ships. Federal tax

equity investors nor-

mally receive 99%

of the profits, loss,

and residual cash

distributions for the initial five

years of the partnership, and

then their interest switches to a

predetermined percentage, usu-

ally 5%, after five years. This is

because the federal recapture

period for the credits the inves-

tor receives is five years, with

the exception of low-income

housing tax credits—which are

not discussed in this article.

Often, the federal equity inves-

tor will receive a 1% to 2%

preferred return on their capital

contribution to the partnership

for the initial five years. Finally,

This article takes a very practical approach to the

reporting of tax equity investments in partner-

ships and limited liability companies (LLCs). While

generally accepted accounting principles (GAAP)

appear to specify the equity method, this article

recommends bifurcation of the investment into

two pieces, one being the present values of the tax

attributes, which should be booked together with

the other tax assets, and the second component

being the present value of expected cash flows

from the investment. © 2016 Wiley Periodicals, Inc.

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