On August 14, 2019, following a nine-day trial, Judge Gustafson of the United States Tax Court issued a rare bench decision in favor of the taxpayer in Cross Refined Coal, LLC v. Commissioner. 1 Winston & Strawn partners Larry Hill and Steve D’Amore represented the developer/ participating partner, AJG Coal, Inc., in the TEFRA partnership case.

Cross was a case of first impression involving an IRS challenge of claimed section 45 tax credits and only the second reported tax case, to our knowledge, where the taxpayer prevailed despite there being no pre-tax profits and the first case involving a challenge to claimed section 45 tax credits.2 The IRS challenged Cross’ claimed section 

45 tax credits which were based on Cross’ production and sale of refined coal. Judge Gustafson, however, concluded that Cross was a bona fide partnership, rejecting the IRS’ arguments that the partners failed to satisfy capital contribution and profit and loss sharing requirements in establishing business purpose and intent. 

Section 45 Credits

Section 45 allows a tax credit for qualified refined coal produced at a qualifying refined coal production facility and sold to an unrelated person during the 10 years after the facility is placed in service, provided that the facility was initially placed in service before January 1, 2012. Refined coal is raw coal that has been treated to make it less polluting when burned in a power plant or factory to make steam. To qualify for the credit, the producer must certify that the refined coal meets certain emissionreduction requirements. There must be at least a 20% reduction in nitrogen oxide emissions and at least a 40% reduction in either sulfur dioxide or mercury emissions compared to burning raw coal. The legislation was intended “to incentivize taxpayers to produce refined coal that significantly reduces harmful emissions during the production of steam to generate electricity by coal-burning utilities that might not otherwise be profitable without the tax credits.”3


In 2010, AJG Coal, Inc., Schneider Electric and Feedstock Investments V (Fidelity) pooled their resources to form the Cross Refined Coal partnership (“Cross”), which engaged in the production and sale of qualified refined coal to Santee Cooper’s Cross Generating Station, the South Carolina Public Service Authority. The Cross refined coal plant was built on leased land adjacent to the Santee Cooper Generating Station. Using a computer-controlled mixing process, Cross applied a proprietary chemical process to create refined coal as defined in Section 45(c)(7). Santee Cooper earned 75¢ a ton from taking the product. It sold the raw coal at cost and then bought back the refined coal for 75¢ less a ton.

The IRS concluded that no real partnership was formed alleging that there was no real business from which the parties intended to share profits. According to the Service, the Cross investors involved with the refined coal production were engaged in the transaction to “monetize” tax credits.

Following an audit of the 2011 and 2012 tax years, the IRS reduced the partnership and certain partners’ Section 45(e)(8) refined coal production tax credits by several million dollars and disallowed several million dollars more of claimed losses. The Notice of Deficiency provided the following reasons for the adjustments:

• Neither the partnership nor the partners have established the existence of the partnership as a matter of fact;

• The formation of the partnership was not, in substance, a partnership for federal income tax purposes because it was not formed to carry on a business or for the sharing of profits and losses from the production or sale of refined coal by its purported members/partners, but rather was created to facilitate the prohibited transaction of monetizing refined coal tax credits;

• The refined coal tax credits are disallowed because the transaction was entered into solely to purchase refined coal tax credits and other tax benefits; and

• Ordinary losses were disallowed because it has not been established that they were ordinary and necessary or credible expenses in connection with a trade or business or other activity engaged in for profit.

Cross filed a petition in the Tax Court seeking a redetermination of partnership adjustments determined by the IRS. Analysis Following a nine-day trial conducted from August 5 through 14, 2019 in Boston, Massachusetts, and after hearing fact and expert testimony, the Tax Court issued a bench opinion that rejected the IRS view that there was no bona fide partnership. The IRS disputed Cross’s status as a bona fide partnership asserting (i) there was a lack of contributions, and (ii) the partners were not co-proprietors, sharing a mutual proprietary interest in the net profits and losses. 


As to the contributions, the court noted that the parties each contributed millions of dollars to the partnership, and the existence of a liquidated damages provision was not inconsistent with the status as partners. In addition, additional contributions were made by the parties when the refined coal facility was shutdown. The court recognized that each investor had to make ongoing capital contributions to cover its share of operating costs in addition to paying to buy an interest in the refined coal facilities. Thus, the court concluded that the contributions to Cross were “commensurate with their status as partners.” The investors were real partners and not bare purchasers of tax credits, the court said. “In this case, we do not have mere paper transactions or distant, passive investors,” but “obviously real transactions with participants substantially involved in the activity.”4

Sharing of Profits and Losses

The IRS argued that the partnership did not share “profits” because the rise of production and sale of refined coal always resulted in increased pre-tax losses, not profits, because Cross had entered into a contract to sell the refined coal to Santee Cooper for 75¢ a ton below cost. But the Tax Court rejected the IRS pre-tax economic analysis and said the arrangements had “economic substance.” The court cited to Sacks v. Commissioner,5 a1995 decision by the Ninth Circuit that concluded it makes no sense to require a pre-tax profit in cases where Congress has offered a tax incentive to do something that would otherwise be uneconomic without the tax subsidy. Thus, the “members do share in increased profit – i.e., after tax profit because of the section 45 credits that are a necessary predicate for the entire arrangement.”6 As to the sharing of losses, the IRS argued that the parties’ contributions were not at risk of loss because when the parties joined Cross as partners, “everything essential to the refined coal operation was already in place.” But the Tax Court disagreed. According to the court, Cross was not like the investment tax credits at issue in Historic Boardwalk. 7 In Historic Boardwalk, the investment credit was received when the investment was made. However, in Cross, the Section 45 credit is a production credit, not an investment credit. The production credit is not earned until the refined coal is produced and sold, which involves future risks that might impede the future production and sale. The court concluded that the parties took significant risks by entering into the transaction. Santee Cooper risked using a product that might damage its boilers, affect the burn temperature for the coal and affect processes in place at its power plants to control harmful emissions. On the other hand, the partners risked being left empty handed after spending money to put the refined coal facilities in place, since Santee Cooper could direct the partnership at any time to turn off the chemicals and let the raw coal move untreated along the conveyors. In fact, Santee Cooper did this multiple times - Santee Cooper  shut down refined coal production “with a frequency that frustrated” the partners, including one shutdown at the Cross power plant that lasted nine months, the court said.8 In addition, the court noted that the ChemMod technology, though well-conceived and tested, had inherent risks that could be mitigated but not eliminated (such as environmental risks). The court said each Cross investor did not have to quantify the risks beyond finding that the risks were not “de minimis or remote but instead were serious risks.” It concluded, “[a]n investor might not run shrieking from these risks, but he would consider that he was bearing these risks as he made his investment.”9

Lastly, the court rejected the IRS’s claim that the parties were involved with the sale of federal tax credits, as the Cross partnership was not “mere paper transactions or distant, passive investors.”10 

“The Tax Court issued a bench opinion that rejected the IRS view that there was no bona fide partnership.”

The Tax Court held that “members do share in increased profit – i.e., after tax profit because of the section 45 credits that are a necessary predicate for the entire arrangement.”