Reducing Active Business Income Taxes With Solar Flip Partnership Purchases • Learn with Valur

Active business income is the lifeblood of many entrepreneurs and self-employed individuals. It represents the earnings generated by actively operating a business or providing services. Whether you are a sole proprietor, a partner in a partnership, or an owner of a closely-held corporation, the income you generate from your active involvement in the business is considered active business income.

However, one of the downsides of active business income is the significant tax burden it carries. Fortunately, there is a solution that can help mitigate these taxes and optimize financial gains: buying solar projects.

The world is pivoting towards sustainable energy solutions and as a result, the federal government will make the single largest investment in climate and energy in American history, providing an estimated $369 billion in tax incentives to shift America’s energy dependance towards renewable energy, including solar.

In this article, we will explore how individuals earning active business income can mitigate their tax burdens and optimize their financial outcomes through buying a solar Flip Partership project, which provides an opportunity to reduce your taxable income.

So let’s get started!

What Are The Financial Benefits Of Buying Solar Projects?

Buying qualified solar projects can substantially reduce active business income taxes. The basic benefits of buying qualified solar infrastructure projects are massive, and we explain them in detail in this article.

In summary, the financial benefits you receive are:

Depreciation: the amount of value that a physical asset loses over time. From a tax standpoint, depreciation is relevant because you can take a deduction for some or all of the amount of the value an asset loses over the first 5 years and primarily in year 1 due to bonus depreciation, reducing your taxable income and saving money on your state and federal taxes.
Tax credits: a dollar-for-dollar reduction in the amount of taxes you owe. The government lets you deduct a certain percentage of the solar project costs from your federal taxes.
Income stream: solar projects that qualify for advantaged tax treatment also typically include years of income streams tied to the sale of energy produced by the project.

You can read more about depreciation here and the benefits of solar tax credits here. In the meantime, let’s jump into a case study to illustrate the potential financial benefits from a sale leaseback solar project.

Active Business Case Study Walk-through

Mike and Mary are a successful couple from California that run an e-commerce company that sells toys. In 2023, their estimated income is $3,000,000 and, as a result, they are looking at $1,509,000 in federal taxes and California taxes at the end of the year. After paying their total taxes, that would leave Mike and his wife with $1,491,000.

Buying a qualifying solar project, however, could earn the couple significant tax credits, depreciation deductions, and ongoing income to mitigate their high tax burden. Below, we’ll walk through how Mike and Mary can buy a solar business to reduce their taxes in 2023.

Specifically, imagine that they choose to invest $700,000 in a flip partnership solar project this year. As a result of this investment, the family could reduce their tax bill in 2023 from $1,509,000 to up to $667,155 and also reduce it by up to $229,638 more in the following 5 years.

Let’s now see the numbers:

Situation Overview:

Income: $3,000,000 in 2023
Expected taxes without solar benefits: $1,509,000

Solar Impact:

Investment: $700,000
Tax Savings: up to $1,071,483

Results:

Total tax savings: As a result of their investment, the couple’s total tax bill will come down from $1.509,000 to up to $437,517. That’s a total reduction in federal and state taxes of up to $1,071,483, or 153% of the $700,000 investment.

Tax Credits: $436,590 in tax savings in the first year, or 62% of the initial investment
Depreciation: $634,893 in tax savings, or 90% of the initial investment. (About 63% of this depreciation credit is available in year 1, and the remainder will be spread over the following 5 years, as you can see in the next table)

Year-by-Year Tax Savings:

Below, you can see the year-by-year tax savings from tax credits and Federal and State depreciation for Mike and Mary taking into account her particular situation. You can also play with our online calculator to customize it with your own numbers and see your potential savings here

Total Income: $35,000. While they will receive some income distributions over the early years, the lion’s share of the project revenue will go to their investment partners as a result of the flip partnership structure. See our guide to solar flip partnerships for more information.

Phantom income tax: -$89,600. Phantom income occurs when an individual is taxed on the value of their stake in a partnership (or another equivalent agreement), even if they do not receive any cash benefits or compensation. For example, if a partnership reports $100,000 in income for a fiscal year–and a partner has a 10% share in the partnership–that individual’s tax burden will be based on the $10,000 in profit reported. Even if that sum is not paid to the partner because, for example, it is rolled over into retained earnings, reinvested in the business or in the case of most solar flip partnerships being used to pay down partnership debt, the partner may still owe tax on the full $10,000. As a result, the couple is taxed on income they never receive or “phantom income”, in this case, for a total of -$89,600.

What if Mike and Mary chose not to start a solar business?

This is, of course, a common question: How would they do if they simply paid their taxes and invested the remaining money? This is a pretty simple comparison as if the family doesn’t invest $700,000 in the solar project, they would owe more than that in taxes and be sending $700,000 to the IRS.

Situation Overview:

Tax bill: $1,509,000
Amount not invested in solar: $700,000
Missed Tax Savings from Solar: up to $1,071,483
Net Loss: -$371,483

Results:

If Mike and Mary chose to pay their taxes instead of investing in solar, they would owe that full tax bill of $1,509,000 Compare that to the additional $153,120 they would gain in tax savings from the flip partnership investment ($1,071,483 in tax savings – $700,000 in the cost of the solar investment).

(The couple also could have earned a different type of return, focused more on ongoing income and less on up-front tax savings, via a “sale leaseback” You can read more about the various solar investment structures here).Hopefully, the benefits from solar investments are now clear, but there are a couple of qualifications and limitations that investors should take into account and you can read more about the mechanics (including “active investor” and other regulatory requirements) here.

What Are The Depreciation And Tax Credit Constraints?

For individuals earning active business income, there is no limit to your depreciation write-off, so there is no depreciation cap in Mike and Mary´s example.

In addition, you can only write-off 75% of your remaining federal tax liability with tax credits (after applying the depreciation tax savings) and if you have excess tax credits for the current tax year, you can apply them to your taxes from the past 3 years or roll them forward and apply them over the next 22 years. For this example, their federal taxable income would be $2,010,398, which is the net value between their $3,000,000 income and their $989,602 savings from federal depreciation (federal tax savings from depreciation in 2023 are $366,153 and assuming a 37% federal tax bracket, Mike and his wife’s saving from depreciation would then be $989,602). Their income would fall into the 37% federal income tax bracket, so their federal income taxes would be around $743,847. The couple could write-off up to $557,885 in year 1 from tax credits (75% of $743,847 for the current tax year, so in this case, they could write-off all $436,590 of their tax credits from the flip partnership project and could invest more to increase their tax savings and returns!)

Hopefully, the benefits from buying solar projects are now clear, but there are a couple of qualifications and limitations that you should take into account and you can read more about the mechanics (including “active participation” and other regulatory requirements) here.

Active Participation Requirement

To qualify for the tax-credit portion of the IRA’s solar program, you will have to have material participation in business. You will need to set up an LLC focused on running your solar business and you will also need to actively participate in your solar business. This is a bit tougher for many, but a couple of features make the requirement less onerous:

Activities like viewing site work (even if you are not an expert) and attending relevant conferences and educational seminars qualify for this hours requirement.
Participation by either spouse is counted toward satisfying the annual hours needed.
Valur streamlines your documentation process, enabling you to save relevant documents and log your participation hours directly on our platform.

You can also read our Active Participation article to understand all the requirements, regulations and activities involved.

Conclusion

Investing in solar projects can help people reduce their active business income taxes. If you have any accounting questions, we have put together an overview of the most common technical doubts accountants have for us and you can read them here.

So, how can you go about investing in qualified projects? It’s relatively simple: Valur has partnered with nationally recognized accounting and investment firms to facilitate investments into solar projects. We will help you identify the opportunity and choose between different solar investment opportunities, visualize the potential benefits, and calculate how much you need to invest to capture the right sized tax credits. From there, we and our partners will help you seamlessly finalize your investment and keep track of the relevant data for ongoing tax purposes. To learn more you can schedule a call with us here.

About Valur

We’ve built a platform to give everyone access to the tax and wealth building tools typically reserved for wealthy individuals with a team of accountants and lawyers. We make it simple and seamless for our customers to take advantage of these hard-to-access tax-advantaged structures so you can build your wealth more efficiently at less than half the cost of competitors. From picking the best strategy to taking care of all the setup and ongoing overhead, we make things simple. The results are real: We have helped create more than $1.1 billion in additional wealth for our customers.

If you would like to learn more, please feel free to explore our Learning Center, check out your potential tax savings with our online calculators, or schedule a time to chat with us!