Navigating Tax Implications When Investing in Infrastructure Auctions — A Primer for High‑Net‑Worth Tech Investors

Hook: Why wealthy tech investors must treat PJM-style infrastructure auctions as a tax problem — not just an energy play

You're a high-net-worth tech investor: you see a once-in-a-decade policy shift — PJM and several Northeastern states moving to create emergency auctions to incent new capacity to meet AI-driven demand (reported in January 2026) — and you want in. Smart. But putting up capital to fund a power plant or capacity contract without a tight tax plan is one of the fastest ways to erase expected returns and invite multi-state audits.

The big picture in 2026: why tax structure matters now

Energy-focused auctions like PJM's emergency capacity procurement are not only operational: they create complex, multi-layered tax consequences. In 2026, three trends make tax planning essential:

• New auction vehicles and government pressure. Reported federal and state efforts to accelerate generation (late 2025–early 2026) mean more bespoke SPVs and public–private arrangements — each with unique tax profiles.
• Expanded clean-energy tax tools post- IRA. The Inflation Reduction Act and implementing rules expanded transferability and direct-pay options for clean-energy tax credits. That affects capital budgeting and partner allocations.
• State tax enforcement is more aggressive. Since Wayfair (2018) and continuing through 2025–26, states have sharpened nexus audits for pass-through entities and nonresident partners; expect more state withholding and apportionment disputes.

Core tax questions every high-net-worth investor must answer before bidding

Before you commit capital, get clear on — and document — the answers to these non-negotiable tax questions:

1. Which entity will hold the asset (LLC taxed as partnership, C corp, REIT, or partnership)?
2. How will auction revenues (capacity payments, availability payments, energy sales) be characterized for tax purposes (ordinary income vs. capital)?
3. What federal tax credits and depreciation rules apply, and how will partners receive credit benefits?
4. Which states will assert nexus for the SPV and for nonresident partners?
5. How will cash distributions, tax distributions, and K-1 timing be handled to avoid “phantom income”?

Structuring basics: entity choice and passthrough tax mechanics

Most PJM-style investments use an LLC taxed as a partnership. Why? Partnerships allow flexible allocation of economic returns, loss utilization, and flow-through of credits and depreciation. But flow-through is a double-edged sword: each partner must report their share of partnership income, gains, losses, and credits on their personal (or corporate) return.

Key partnership concepts to negotiate and document

• Capital accounts and tax basis: Partner basis determines the ability to use losses and take distributions tax-free. Make sure capital-account mechanics conform to Treasury Regulations (Section 704(b)).
• Allocations and substantial economic effect: Special allocations (e.g., disproportionate depreciation or credit allocations to tax-efficient partners) must have substantial economic effect or meet the alternative test in Section 704(b) to be respected for tax purposes.
• Guaranteed payments vs. preferred returns: Guaranteed payments are ordinary income to the recipient and deductible by the partnership. Preferred returns may be treated as part of a partnership distribution; document treatment clearly.
• Allocation of tax credits: Investment Tax Credit (ITC) or Production Tax Credit (PTC) allocations must be carefully written so partners receive the intended tax benefit; recent rules permit transfer/assignability in some cases.

How passthrough allocations work in practice (example)

Example: You invest $50M as a limited partner into an LLC that builds a 200 MW peaker plant and secures capacity payments under a PJM-like auction. The SPV takes depreciation and claims certain energy credits. The partnership agreement allocates 80% of economic returns to lead equity and 20% to your passive stake, but it also grants a credit allocation that assigns 60% of ITC to you because you can immediately use the credit against other tax liabilities.

Tax effect summary:

• Partnership reports capacity payments as ordinary income; taxable allocations flow to partners via K-1s.
• Your share of depreciation reduces your taxable partnership income; if losses exceed basis, you’re not currently deductible until basis increases.
• Special allocation of ITC must be supported by allocations of tax items and economic arrangements; otherwise, the IRS could reallocate credits.

State nexus and multi-state filing traps

Investing in physical generation almost always creates state tax nexus for the SPV and can create filing obligations for nonresident partners. Expect four common state-level taxes:

• Corporate or partnership income tax — SPV files where the plant is located and possibly where energy is sold.
• Nonresident partner withholding — many states require withholding on distributive shares allocable to nonresident partners.
• Sales and use tax — equipment purchases, interconnection charges, and certain services may trigger tax.
• Property tax — local property tax assessments can be a major ongoing cost and lien risk.

Practical state-nexus checklist

1. Map every state where the SPV will have physical property, employees, contractors, or services.
2. Confirm whether capacity revenues are sourced to the plant location or to the utility/market. States vary on sourcing rules.
3. Budget for state-level withholding (often 5–8% of allocable income) and build withholding mechanics into the LP agreement.
4. Plan for sales/use tax exemptions on renewable equipment or specific energy construction projects — secure rulings when possible.
5. Reserve for local property tax appeals and understand assessment timelines; include cost-sharing for litigation in the operating agreement.

Credits, depreciation and cashflow timing — the 2026 toolbox

Post-2022 IRA rules and 2023–2025 guidance have increased the available levers for energy investors. In 2026, consider these tools:

• Investment and Production Tax Credits (ITC/PTC): Often applicable for qualifying generation. Credits reduce federal tax liability but require careful allocation and basis adjustments.
• Bonus depreciation and MACRS: Depreciation accelerates tax deductions and improves near-term cashflow but can create large book–tax differences that must be allocated.
• Direct-pay and transferability: Under IRA-era programs and implementing regs, some credits can be transferred or paid directly to otherwise tax-exempt partners — a game-changer for structuring capital stacks.

Structuring tip: pairing tax-efficient partners with credits

If the SPV is expected to generate large credits, you can structure preferred credit allocations to partners who have near-term tax appetite (high-income founders, corporate investors). If you expect tax-exempt or foreign investors, consider using a domestic blocker corporation to monetize credits without creating unrelated business taxable income (UBTI) for the exempt investor.

Audit risk and the centralized partnership audit regime (what to expect)

Partnerships are audited under the centralized partnership audit regime created by the Bipartisan Budget Act of 2015. In 2026, audits of energy SPVs are more likely because of high-dollar credits and complex allocations.

• Partnership-level adjustments: Under the centralized regime, tax adjustments are made at the partnership level. The partnership may pay the tax and seek contribution from partners, or elect a push-out.
• Documentation is critical: Maintain contemporaneous allocation worksheets, economic models, and partnership minutes that show the economic effect behind allocations.
• Indemnities and reserve mechanics: Your operating agreement should include indemnity provisions for misallocated credits or unexpected state assessments.

International investors and blockers

Foreign or tax-exempt investors (foundations, pension funds) face special tax rules. Direct participation in a partnership that earns effectively connected income (ECI) or allocable U.S. source income can create U.S. filing obligations and withholding.

• Use of blocker corporations: A U.S. C corporation between the partnership and the foreign/exempt investor can shield investors from direct U.S. tax filings, but it creates a layer of corporate tax and reduces pass-through efficiencies.
• Withholdings on effectively connected income: Design your capital stack and agreements to accommodate withholding and to allocate tax burdens fairly among partners.

Examples of tax structuring strategies used by experienced investors

Below are tested structures; they require bespoke work and should be implemented with tax counsel.

1. Tax-efficient credit allocation: Group tax-active investors into a class that receives a disproportionate share of ITC/PTC and depreciation. Provide economic compensation (priority return or fee) so the economic distribution matches tax allocations.
2. Credit syndication via transferability: Use transferrable credit mechanisms (where available) to sell credits to third parties if partners lack tax capacity. Factor in market discounts and transferability compliance costs.
3. State withholding reserve: Dedicate a cash-reserve line to satisfy anticipated state withholding; release excess after audit windows expire.
4. Capital-account equalization provisions: Use clear equalization and curative allocations to ensure book and tax capital accounts remain aligned under Section 704(b).

Red flags and common mistakes — avoid these

• Poorly documented special allocations: IRS recharacterizes allocations that lack economic substance or are not supported by the partnership agreement.
• No plan for K-1 timing: Late K-1s or mismatches between cash distributions and taxable allocations create liquidity issues for partners required to pay tax without receiving cash.
• Underestimating state nexus: Treating a single-state investment as a federal-only matter invites multi-state audits and unexpected tax bills.
• Ignoring credit compliance rules: Failing wage-and-apprenticeship or domestic-content tests can disqualify credits and lead to recapture.

Practical, step-by-step pre-bid tax checklist

1. Engage national tax counsel and a state tax advisor with energy experience.
2. Run a preliminary tax model that shows taxable income, book income, and cash distribution timing under stress cases.
3. Design the SPV’s entity form and draft an operating agreement that specifies allocations, tax distributions, and withholding mechanics.
4. Obtain state-specific rulings for sales/use tax and property tax when feasible.
5. Identify credit transferability and direct-pay options; model monetization scenarios.
6. Plan for audit defense budget and partnership-level reserves or indemnities.

Case study: a $100M SPV in 2026 — what happened and why

Hypothetical but realistic:

A group of tech investors formed an LLC to build flexible capacity under a PJM emergency auction in early 2026. The SPV claimed ITC-equivalent credits under updated energy rules and accelerated depreciation. Two nonresident partners were surprised when five Northeastern states issued withholding notices totaling 4% of their allocable shares. Because the operating agreement lacked clear withholding mechanics, the partnership had to advance cash to satisfy state demands, compressing distributions to investors for two years. The lesson: early planning for state withholding and documented cash reserves could have preserved expected yield.

Real-world takeaway: If you plan to deploy meaningful capital into capacity auctions, structure the SPV to anticipate multi-state tax exposure and align tax allocations with who can actually use credits.

Tax forecasting and reporting: tools & best practices

• Monthly tax P&L: Maintain a tax P&L updated monthly to track book-to-tax adjustments and projected partner basis.
• K-1 timeline and automation: Use tax software that integrates with your fund accounting to produce timely K-1s and state composite returns.
• Quarterly state nexus review: As contractors, interconnection, and operations activities ramp up, run a quarterly nexus checklist with state counsel.
• Audit-ready documentation: Keep contemporaneous minutes and allocation worksheets; obtain written legal and technical opinions supporting credit eligibility.

Looking ahead: 2026–2028 predictions for investors in auction-funded generation

• More aggressive state audits: States will continue to look for high-dollar targets — expect more nexus assertions and multi-state filings.
• Refined IRS guidance on credit transferability: As the market for transferable credits matures, additional guidance will shape how partnerships monetize credits.
• Hybrid capital stacks proliferate: Expect greater use of tax equity, mezzanine debt, and credit syndication to balance tax efficiency and control.
• Standardization of operating agreements: Market templates for power-plant SPVs will emerge, but customized provisions will remain essential for large investors.

Final checklist before you bid — concise action items

• Confirm entity form and operating agreement language on allocations and tax distributions.
• Model federal and state tax cashflow, including withholding and property taxes.
• Identify partners’ tax capacity and assign credits accordingly or build a transfer/sale plan.
• Implement a reserve for state audits and K-1 timing mismatches.
• Engage counsel to secure rulings for material items when available.

Who to call on your deal team

Assemble this core team early:

• Energy tax partner from a national law firm (partnership, credits, federal tax).
• State and local tax specialist familiar with property and nexus audits.
• Transaction counsel experienced in PJM and capacity markets.
• Fund/accounting team able to produce monthly tax P&Ls and timely K-1s.
• Independent technical expert for credit eligibility and wage/apprenticeship compliance.

Closing: Build the tax plan before you write the check

Infrastructure auctions like the new PJM-style capacity procurements present compelling returns for tech investors in 2026. But the tax landscape is nuanced and evolving. The right structure preserves yield, reduces audit risk, and ensures you get the cash you expect — not just paper tax benefits.

Actionable takeaways: (1) Treat tax structure as part of bid strategy; (2) Draft clear allocation and withholding mechanics in your operating agreement; (3) Get state tax buy-in early; (4) Model cash distributions under adverse scenarios; (5) Secure audit and compliance budgets.

Call to action

If you’re evaluating a bid or building an SPV for a PJM-style capacity auction, don’t sign form documents. Download our investor-ready tax-structuring checklist and schedule a short consultation with a senior energy tax strategist to run your preliminary tax model. Early diligence will save capital and protect returns.

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