Cross Refined Coal, LLC v. Commissioner of Internal Revenue

United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued April 12, 2021 Decided August 5, 2022
No. 20-1015
CROSS REFINED COAL, LLC, ET AL.,
APPELLEES
v.
COMMISSIONER OF INTERNAL REVENUE,
APPELLANT
Appeal from the United States Tax Court
Norah E. Bringer, Attorney, U.S. Department of Justice,
argued the cause for appellant. With her on the briefs was
Arthur T. Catterall, Attorney.
Timothy S. Bishop argued the cause for appellees. With
him on the brief were Brian W. Kittle, Geoffrey M. Collins, Joel
V. Williamson, David W. Foster, Robert S. Walton, and
Lawrence M. Hill. Colleen Campbell entered an appearance.
Michael B. Kimberly, Paul W. Hughes, and Daryl Joseffer
were on the brief for amici curiae the Chamber of Commerce
of the United States of America and the National Mining
Association in support of appellees. Steven P. Lehotsky entered
an appearance.

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Before: MILLETT, KATSAS, and RAO, Circuit Judges.
Opinion for the Court filed by Circuit Judge KATSAS.
KATSAS, Circuit Judge: Congress enacted a tax credit to
incentivize the production of refined coal, which releases fewer
emissions than unrefined coal. AJG Coal, Inc. responded by
forming Cross Refined Coal, LLC and recruiting two other
investors in that enterprise. Limited-liability companies are
taxed like partnerships, so the company’s tax liabilities and
credits passed through to its member investors. Yet the Internal
Revenue Service balked when Cross’s members tried to claim
the refined-coal credit. The IRS asserted that Cross was not a
bona fide partnership for tax purposes, in part because it could
never have made a profit without the tax credit. The tax court
disagreed, and so do we. We hold that partnerships formed to
conduct activity made profitable by tax credits engage in
legitimate business activity for tax purposes. We further
conclude that all of Cross’s members shared in its profits and
losses, and thus had a meaningful stake in its success or failure.
Accordingly, we affirm the tax court’s conclusion that Cross
was a bona fide partnership.
I
A
In 2004, Congress created a refined-coal tax credit to
promote the production of treated, cleaner-burning coal. 26
U.S.C. § 45(c)(7)(A). Taxpayers that opened refined-coal
production facilities before 2012 could claim a tax credit for
each ton sold over the following ten years. Id. § 45(d)(8),
(e)(8). If multiple taxpayers had an ownership interest in a
facility, the credit was allocated according to their respective
ownership shares. Id. § 45(e)(3). Initially, a producer could

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receive the credit only if it sold the refined coal for 50% more
than the market value of unrefined coal. American Jobs
Creation Act of 2004, Pub. L. No. 108-357, § 710(a)(7)(A)(iv),
118 Stat. 1418, 1553. Congress lifted that restriction in 2008,
after the tax credit had failed to stimulate significant
investment in refined coal. Energy Improvement and
Extension Act of 2008, Pub. L. No. 110-343, Div. B, Tit. I,
§ 101(b)(1)(A), 122 Stat. 3765, 3808.
B
Shortly after Congress expanded the refined-coal tax
credit, AJG Coal, Inc. began developing coal-refining
technology. It then set out to launch a coal-refining facility at
the Cross Generating Station in South Carolina. To do so, it
formed a new subsidiary, Cross Refined Coal, LLC, which
made three key contracts. First, Cross signed a lease with the
utility that owned the generator, Santee Cooper. The lease
allowed Cross to build and operate a coal-refining facility in
the middle of the station. Second, Cross and Santee entered
into a purchase-and-sale agreement. Cross would buy
unrefined coal from Santee, refine it, and then sell it back to
Santee for $0.75 less per ton, ensuring that Cross would lose
money on each resale. Third, Cross entered into a sub-license
agreement with AJG to use its coal-refining technology. AJG
made similar arrangements at two other Santee-owned
generating stations, Jefferies and Winyah, forming separate
LLCs to do business at each.
Cross’s business model made economic sense only by
accounting for the tax credit. Considering (1) the operating
expenses that Cross incurred to refine coal, (2) the losses it
sustained in buying and then re-selling the coal, and (3) the
royalties it paid to obtain the necessary technology, Cross’s
operations inevitably would produce a pre-tax loss. Its sole

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opportunity to turn a profit was to claim a tax credit that
exceeded these costs. Consistent with this tax-centric model,
Cross’s lease, purchase-and-sale agreement, and sub-license all
had ten-year terms matching the ten-year window during which
it could generate tax credits. See 26 U.S.C. § 45(e)(8)(A)(i).
Cross built the refining facility and began to operate it in
December 2009. Over the next four months, AJG recruited two
other members to Cross: Fidelity Investments and Schneider
Electric, both acting through subsidiaries. For AJG, bringing
other investors into Cross had two primary benefits. First, the
new members’ investments enabled AJG to spread its own
investment over a larger number of projects. This allowed AJG
to reduce its overall risk and to collect useful data from plants
with differing characteristics, without exceeding its parent
company’s limited appetite for coal investments. Second,
AJG’s parent company could claim only a fraction of the
refined-coal tax credits in any given year; it would have had to
carry the rest forward. Because money has a time value, it
made sense to have partners who could claim the credits
sooner. See 26 U.S.C. § 702(a)(7) (each partner separately
reports its share of the partnership’s tax credits).
AJG projected that Cross would realize a $140 million
after-tax profit over ten years. After several months of due
diligence, Fidelity purchased a 51% indirect stake in Cross for
$4 million. The purchase agreement contained a liquidated-
damages provision allowing Fidelity to exit Cross and receive
a prorated portion of its investment if Cross did not meet
certain benchmarks. Schneider purchased a 25% ownership
share for $1.8 million, with no provision for liquidated
damages. Fidelity and Schneider also contributed about $1.1
million and $564,000 respectively to cover two months of

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Cross’s operating expenses.1 Finally, Fidelity and Schneider
invested in the LLCs to produce refined coal at the Jefferies
and Winyah generating stations.
Between 2010 and 2013, all three members of Cross were
actively involved in its operations. Each reviewed daily
production reports, signed off on major decisions, and
communicated regularly with Cross management. Each
member also made monthly contributions to cover Cross’s
operating expenses such as payroll, health insurance, and
materials. They paid these amounts in arrears, by reimbursing
Cross for the prior month’s expenses. The contributions were
proportional to each member’s ownership share.
Cross proved profitable, but it endured two lengthy
shutdowns that ultimately ended the partnership. First,
permitting issues caused Cross to halt production between
November 2010 and August 2011. Second, increased bromine
levels at a nearby lake caused another shutdown beginning in
May 2012. During these shutdowns, Cross incurred about $2.9
million in operating expenses, which were not offset by the
generation of tax credits. In March 2013, as Cross languished
through its second shutdown, AJG bought out Schneider’s
interest for $25,000. In November 2013, Fidelity exited Cross
and received about $2.5 million in liquidated damages.
Over the four years when Fidelity and Schneider were
members of Cross, the company generated almost $19 million
in after-tax profits—a substantial amount to be sure, but a far
cry from the lofty projections that AJG had forecast in
recruiting Fidelity and Schneider. The other refining projects
were less successful. In October 2012, Santee shut down the
1 The tax court reported these figures as slightly lower, but we
agree with the Commissioner that the discrepancies are immaterial
in this appeal. Appellant Br. at 14 n.5.

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Jefferies coal-refining operation because of insufficient
demand for local power. As a result, Fidelity and Schneider
suffered after-tax losses of $2.9 million and $700,000
respectively on their investments in the Jefferies LLC.
C
For the 2011 and 2012 tax years, Cross claimed more than
$25.8 million in refined-coal tax credits and $25.7 million in
ordinary business losses. Because LLCs are taxed as
partnerships by default, Cross distributed the credits and losses
among its three members proportionally. See 26 C.F.R.
§ 301.7701-3(b)(1). But in June 2017, the IRS issued a notice
of final partnership administrative adjustment. It determined
that Cross was not a partnership for federal tax purposes
“because it was not formed to carry on a business or for the
sharing of profits and losses,” but instead “to facilitate the
prohibited transaction of monetizing ‘refined coal’ tax credits.”
A. 556. Accordingly, the IRS concluded that only AJG could
claim the tax credits.
Cross sought a readjustment in the tax court under 26
U.S.C. § 6234(a)(1). That court ruled that Cross was a “bona
fide partnership” because all three members made substantial
contributions to Cross, participated in its management, and
shared in its profits and losses. A. 1818–32.
II
On appeal, the Commissioner contests the conclusion that
Cross was a bona fide partnership. We have jurisdiction under
26 U.S.C. § 7482(a)(1). We review tax court decisions “in the
same manner and to the same extent as decisions of the district
courts in civil actions tried without a jury.” Id. Therefore, we
review the tax court’s legal conclusions de novo and its
findings of fact and determinations of mixed questions for clear

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error. Andantech L.L.C. v. Comm’r, 331 F.3d 972, 976 (D.C.
Cir. 2003). Under clear-error review, we may overturn the tax
court’s findings only if we have a “definite and firm
conviction” that the court committed a “serious mistake as to
the effect of evidence.” BCP Trading & Invs., LLC v. Comm’r,
991 F.3d 1253, 1263 (D.C. Cir. 2021) (cleaned up).
A
Because of the special benefits that the tax code affords
partnerships, businesses face “special temptations to appear as
a partnership” for tax purposes. Comm’r v. Culbertson, 337
U.S. 733, 752 (1949) (Frankfurter, J., concurring); see
Southgate Master Fund, L.L.C. ex rel. Montgomery Cap.
Advisors, LLC v. United States, 659 F.3d 466, 483 (5th Cir.
2011) (“many abusive tax-avoidance schemes are designed to
exploit the [Internal Revenue] Code’s partnership provisions”).
One aspect of partnership taxation is particularly alluring:
Partnerships are not taxed at the entity level. Instead, a
partnership’s tax burdens and benefits pass through to the
partners. 26 U.S.C. § 701. Thus, a business can offset its own
tax liability if it is a partner in an entity that generates a tax loss.
See, e.g., ASA Investerings P’ship v. Comm’r, 201 F.3d 505,
506 (D.C. Cir. 2000).
Even if an enterprise formally organizes itself as a
partnership—for example, by filing the appropriate paperwork
under state law—it is not treated as a partnership for federal tax
purposes unless it qualifies as a partnership under federal law.
Yet the tax code does not supply a comprehensive definition of
the term “partnership.” It states only that “[t]he term
‘partnership’ includes” certain kinds of entities, 26 U.S.C.
§ 7701(a)(2), and the IRS’s anti-abuse regulations merely
explain that a partnership must be “bona fide,” 26 C.F.R.
§ 1.701-2(a)(1).

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Without any legal text to construe, we are guided by the
Supreme Court’s definition of partnership, which is based on
background partnership law. Comm’r v. Tower, 327 U.S. 280,
286 (1946); see Culbertson, 337 U.S. at 751 n.1 (Frankfurter,
J., concurring) (“use of the words ‘The term “partnership”
includes’ presupposes that the term has a recognized content”
which “can only be found in the general law of partnership”).
In Tower, the Court held that a partnership is formed where two
or more persons “intend[] to join together for the purpose of
carrying on business and sharing in [its] profits or losses.” 327
U.S. at 287. Three years later, the Court reiterated that “the
parties [must] in good faith and acting with a business purpose
intend[] to join together in the present conduct of the
enterprise.” Culbertson, 337 U.S. at 742. The question of
“bona fide intent” to form a partnership is one of fact, which
depends on a totality of the circumstances. Id. at 741–43.
The partnership definition in Tower and Culbertson
consists of two requirements. First, the partners must intend to
“carry on business as a partnership.” Tower, 327 U.S. at 287;
Culbertson, 337 U.S. at 742–43. In other words, the enterprise
must be “undertaken for profit or for other legitimate nontax
business purposes.” BCP Trading, 991 F.3d at 1271 (cleaned
up). In most cases, this inquiry turns on whether the
partnership has a genuine opportunity to make a profit and
whether the partners direct their efforts toward realizing it. See
id. at 1271–72. In contrast, a partnership that has “no practical
economic effect other than the creation of tax losses” is treated
as a sham. Id. at 1272; see ASA Investerings, 201 F.3d at 506
(finding sham partnership where “transactions that in substance
added up to a wash were transmuted into ones generating tax
losses of several hundred million dollars”). Other factors that
are probative of a sincere intent to carry on a business include
the duration of the partnership, see Andantech, 331 F.3d at 979,
and the business rationale for using the partnership form, id. at

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980; Boca Investerings P’ship v. United States, 314 F.3d 625,
632 (D.C. Cir. 2003).
Though we look to economic reality in assessing intent to
carry on a business, we do not lightly set aside de jure
partnerships as shams. “It is uniformly recognized that
taxpayers are entitled to structure their transactions in such a
way as to minimize tax,” ASA Investerings, 201 F.3d at 513, so
“[t]ax minimization as a primary consideration is not
unlawful,” BCP Trading, 991 F.3d at 1272. Taxpayers that
structure their dealings to receive tax benefits afforded by
statute are entitled to those benefits, no matter their subjective
motivations. Otherwise, the sham-partnership doctrine, like
the more general economic-substance doctrine, would allow
the Commissioner “to place labels on transactions to avoid
textual consequences he doesn’t like.” Summa Holdings, Inc.
v. Comm’r, 848 F.3d 779, 787 (6th Cir. 2017).
The second requirement of the Supreme Court’s definition
of partnership is that the partners must intend to “shar[e] in the
profits or losses or both.” Tower, 327 U.S. at 287. In other
words, the partners’ interests must have the “prevailing
character” of equity, with each partner having a “meaningful
stake in the success or failure” of the partnership. TIFD III-E,
Inc. v. United States, 459 F.3d 220, 231–32 (2d Cir. 2006). If
one putative partner is insulated from the upside and downside
risks of the business, its interest resembles that of a secured
creditor, not an equity partner. See Historic Boardwalk Hall,
LLC v. Comm’r, 694 F.3d 425, 462 (3d Cir. 2012) (“a
partnership, with all its tax credit gold, can[not] be conjured
from a zero-risk investment”); Southgate, 659 F.3d at 486–89.
In our circuit, the leading case on partnership validity
epitomizes the failure to meet these two requirements. In ASA
Investerings, a U.S. corporation seeking to offset a large capital

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gain formed a putative partnership with a foreign bank not
subject to U.S. tax. 201 F.3d at 508. During its brief existence,
the partnership executed only two transactions: the purchase
and offsetting sale of certain debt instruments. Id. Relying on
the tax code’s installment-sale rules, the partners engaged in
wash transactions that created a large capital gain for the tax-
indifferent bank and a large capital loss (and accompanying tax
deduction) for the U.S. corporation. Id.
We held that the purported partnership was not bona fide.
First, the partners did not intend to carry on a business together,
for the partnership was not designed to be profitable on a pre-
or post-tax basis, and it had no other apparent non-tax business
purpose. 201 F.3d at 513–14. The partnership claimed that it
hoped to profit from a change in interest rates between the time
of the offsetting transactions, but we found that they were
designed to eliminate all relevant risks. Id. at 514. Second,
and relatedly, the foreign bank did not share in the supposed
risk of the putative partnership. Instead, it received a
guaranteed rate of return for its participation and faced only a
“de minimis risk” to its investment. Id. at 514–15 (“A partner
whose risks are all insured at the expense of another partner
hardly fits within the traditional notion of partnership.”).
B
Applying these principles, we agree with the tax court that
Cross satisfies the federal definition of a partnership.
1
First, the tax court correctly determined that AJG, Fidelity,
and Schneider intended to jointly carry on a business. As the
tax court found and the government concedes, AJG had
legitimate non-tax motives for forming Cross and for recruiting
partners, such as spreading its investment risk over a larger

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number of projects. Moreover, there was nothing untoward
about seeking partners who could apply the refined-coal credits
immediately, rather than carrying them forward to future tax
years. Low-tax entities (like AJG) often use the prospect of tax
credits to attract high-tax entities (like Fidelity and Schneider)
into a partnership, and in return, the high-tax partners provide
the financing needed to make the tax-incentivized project
possible. See Va. Historic Tax Credit Fund 2001 LP v.
Comm’r, 639 F.3d 129, 132–33 (4th Cir. 2011); Office of the
Comptroller of the Currency, Low-Income Housing Tax
Credits: Affordable Housing Investment Opportunities for
Banks 1–3 (last updated Apr. 2014). And Congress expressly
provided for coal refiners to employ this investment strategy,
for the tax code specifies how the credit must be divided when
a refining facility has multiple owners. 26 U.S.C. § 45(e)(3).
Cross therefore fits comfortably within the scope of entities
that Congress envisioned claiming the credit.
Fidelity and Schneider, while no doubt motivated by the
prospect of refined-coal tax credits, also became legitimate
partners in the enterprise. Though AJG did much of the heavy
lifting to launch Cross, Fidelity and Schneider jointly
controlled its major decisions once they became members, and
they were actively involved in its day-to-day operations. Both
also made monthly contributions to Cross “commensurate with
their status as partners”—Fidelity contributed $26 million, and
Schneider contributed $12.3 million. A. 1821–22. And both
remained members of Cross for several years, even during
unprofitable shutdowns.
The Commissioner’s chief objection is that Cross did not
pursue business activity to obtain a pre-tax profit. Instead, tax
credits were its sole profit driver, and the production of those
credits thus permeated every aspect of its business model.
According to the Commissioner, Cross’s partners did not have

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the requisite intent to carry on a business together because
Cross was not “undertaken for profit or for other legitimate
nontax business purposes.” BCP Trading, 991 F.3d at 1271
(cleaned up) (emphasis added).
We disagree. As a general matter, a partnership’s pursuit
of after-tax profit can be legitimate business activity for
partners to carry on together. This is especially true in the
context of tax incentives, which exist precisely to encourage
activity that would not otherwise be profitable. The production
of refined coal illustrates this point: Congress recognized its
environmental benefits, but, as the tax court explained, refiners
must sell it at a discount “in order to induce the utility to assume
the risk of buying and using” it. A. 1792–93. Thus, Cross did
not simply engage in “wasteful activity,” which is typical of
sham partnerships that merely manufacture tax losses. ASA
Investerings, 201 F.3d at 513. Rather, Cross engaged in
business activity with a “practical economic effect,” BCP
Trading, 991 F.3d at 1272—the production of cleaner-burning
refined coal, which Congress specifically sought to encourage.
The Ninth Circuit has likewise held that taxpayers may
legitimately conduct business activity that Congress has
deliberately made profitable through statutory tax incentives—
and may do so with no hope of a pre-tax profit. In Sacks v.
Commissioner, 69 F.3d 982 (9th Cir. 1995), that court
explained: “If the government treats tax-advantaged
transactions as shams unless they make economic sense on a
pre-tax basis, then it takes away with the executive hand what
it gives with the legislative.” Id. at 992. For “Congress has
purposely used tax incentives” to “induce investments which
otherwise would not have been made,” and “[i]f the
Commissioner were permitted to deny tax benefits when the
investments would not have been made but for the tax
advantages, then only those investments would be made which

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would have been made without the Congressional decision to
favor them.” Id. at 991–92. The Commissioner’s view would
thus hamstring Congress’s ability to use tax credits to
encourage all kinds of activity that is socially desirable but
unprofitable to those undertaking it—such as building low-
income housing, 26 U.S.C. § 42; producing renewable energy,
id. § 45; or developing medicines for rare diseases, id. § 45C.
The Commissioner falls back to the position that a
partnership is bona fide only if each partner expects to make a
pre-tax profit “at some point in time.” Reply Br. at 23–24. He
invokes Alternative Carbon Resources, LLC v. United States,
939 F.3d 1320 (Fed. Cir. 2019), which held that a taxpayer
could not claim an alternative-fuel tax credit absent evidence
that it “ever reasonably expected to generate any profit apart
from the tax credits.” Id. at 1330 (cleaned up). Like the
Commissioner, Alternative Carbon sought to distinguish Sacks
as a case where the taxpayer could eventually turn a pre-tax
profit. Id. at 1331. But Sacks did not turn on that possibility;
to the contrary, it explained that an investment does “not
become a sham just because its profitability was based on after-
tax instead of pre-tax projections.” 69 F.3d at 991. And even
Alternative Carbon acknowledged that a transaction
“unprofitable absent a tax credit” may still have economic
substance if it “meaningfully alters the taxpayer’s economic
position (other than with regard to the tax consequences)” and
has a “bona fide business purpose.” 939 F.3d at 1331–32
(cleaned up). Cross passes muster under this test: Its partners
all made sizable contributions to become part owners and help
Cross engage in the business of producing refined coal.
The Commissioner also points to our remark in ASA
Investerings that “the absence of a nontax business purpose is
fatal” to bona fide partnership status. 201 F.3d at 512. But
transactions that are profitable only on a post-tax basis can still

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have a “nontax business purpose.” The ASA partnership—an
“elaborate” scheme that engaged in “wasteful activity” with
“very substantial transaction costs”—had no purpose apart
from the creation of tax losses. Id. at 513, 516. Indeed, the
partnership itself could not profit even on a post-tax basis,
making it “no more than a facade.” Id. at 513–14. Cross, on
the other hand, sought to produce a post-tax profit, and it did
so by pursuing the congressionally encouraged business
purpose of producing refined coal. Moreover, its use of the
partnership form furthered that purpose by enabling AJG to
raise more capital and spread its investment risk across
multiple coal-refining projects.
Even the Commissioner ultimately recognizes that an
enterprise profitable only on a post-tax basis can have a valid
business purpose. He acknowledges that Cross would have had
a legitimate business purpose had AJG alone operated it, even
with no potential for pre-tax profit. But if one entity could
validly seek after-tax profit through Cross, there is no reason
why three partners could not validly pursue the same objective.
2
The tax court also correctly concluded that Fidelity and
Schneider shared in Cross’s potential for profit and risk of loss,
giving their investment the prevailing character of equity. If
Cross refined more coal, Fidelity and Schneider made more
money. If Cross struggled—whether due to regulatory
obstacles, environmental problems, or shortcomings in the
newly developed refining technology—Fidelity and Schneider
would lose money. And Cross did at times struggle: During
its two shutdowns, it incurred almost $2.9 million in operating
expenses without generating any offsetting revenue. As

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partners, Fidelity and Schneider were liable for, and paid, their
pro rata shares of those expenses.
To be sure, Fidelity and Schneider were insulated from
some of Cross’s downside risk. Most notably, Fidelity’s
purchase agreement contained the liquidated-damages
provision. Likewise, Cross’s sub-license agreement was
structured to protect Fidelity and Schneider from minor
fluctuations in variable operating costs. But these provisions
hardly made their investments effectively like debt, for which
funds are “advanced with reasonable expectations of
repayment regardless of the success of the venture” rather than
being “placed at the risk of the business.” Gilbert v. Comm’r,
248 F.2d 399, 406 (2d Cir. 1957). By and large, Fidelity and
Schneider’s fortunes rose or fell with the amount of coal that
Cross refined, which made them bona fide equity partners. See
Historic Boardwalk, 694 F.3d at 459 (“a limited partner’s
status as a bona fide equity participant will not be stripped away
merely because it has successfully negotiated measures that
minimize its risk of losing a portion of its investment”); Hunt
v. Comm’r, 59 T.C.M. (CCH) 635, 648 (1990) (bona fide
partner could have a 98% guaranteed return of its capital
contribution).
The Commissioner acknowledges that Fidelity and
Schneider faced downside risk, but he contends that it was not
meaningful given the magnitude of the expected tax benefits.
In support of this argument, the Commissioner invokes cases
relying on the economic-substance doctrine, which evaluates
transactions based on economic reality as opposed to formal
labels. See Gregory v. Helvering, 293 U.S. 465, 468–70
(1935). The cited cases assessed the legitimacy of offshore
transactions that gave rise to large U.S. tax losses. Bank of N.Y.
Mellon Corp. v. Comm’r, 801 F.3d 104, 106–07 (2d Cir. 2015);
Reddam v. Comm’r, 755 F.3d 1051, 1055–57 (9th Cir. 2014).

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In these cases, the courts compared the magnitude of the
expected tax and non-tax benefits to gauge whether the
disputed transactions had a legitimate business purpose. Bank
of N.Y. Mellon, 801 F.3d at 120; Reddam, 755 F.3d at 1061.
Similar logic applies to sham-partnership analysis, the
Commissioner contends, as evidenced by our statement in ASA
Investerings that “any potential gain from the partnership’s
investments was in its view at all times dwarfed by its interest
in the tax benefit.” 201 F.3d at 513.
In this case, the Commissioner modifies the comparison
and balances capital placed at risk with the expected tax
benefits. He asserts that at most, Fidelity and Schneider
respectively placed at risk about $4 million and $3 million,
which represent the sum of (1) the initial buy-in amounts (less
the amount that Fidelity later received in liquidated damages),
(2) the initial contributions to cover two months of operating
expenses, and (3) the monthly contributions to cover operating
expenses during shutdown months when no tax credits accrued.
On the other side of the ledger, Fidelity and Schneider
anticipated that, under a best-case scenario, they would
collectively earn $105 million in after-tax profit over ten years.
The Commissioner contends that this imbalance between the
relatively small amounts that Fidelity and Schneider placed at
risk and the large expected tax benefits shows that they merely
bought tax credits rather than becoming true equity partners.2
2 The Commissioner argues that the tax court, in evaluating the
extent of Fidelity and Schneider’s risk, improperly considered
operating expenses accrued during non-shutdown months when
Cross produced refined coal and thus earned the tax credit. The tax
court did not do so. See A. 1825–32. But regardless of whether these
expenses are considered, we conclude that Fidelity and Schneider
had meaningful downside risk.

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We reject this argument. The cited economic-substance
cases compared expected tax and non-tax benefits to discern
the nature of the contested transactions for tax purposes. As
explained above, Congress recognized the environmental
benefits of cleaner coal and provided tax incentives that it
deemed appropriate as a result. We thus cannot ignore tax
consequences in assessing the legitimacy of the encouraged
activity. By contrast, the financial engineering in Bank of New
York Mellon and Reddam had no “practical economic effects,”
Reddam, 755 F.3d at 1062 (quoting Sacks, 69 F.3d at 987);
Bank of N.Y. Mellon, 801 F.3d at 120 (similar), and the
comparison between the transactions’ tax and non-tax benefits
confirmed that they lacked substance. As for ASA Investerings,
the putative partnership activity there was unprofitable even on
a post-tax basis, in contrast to the activity here of producing
refined coal. Also, in weighing expected benefits, the
Commissioner relies on a best-case scenario “assum[ing]
uninterrupted high volume sales of refined coal over the entire
10-year period,” A. 1794, rather than a more realistic, risk-
adjusted projection.
Moreover, even if we accepted the Commissioner’s
modification and compared capital placed at risk to anticipated
tax benefits under a best-case scenario, we still see no reason
to doubt Fidelity and Schneider’s status as bona fide partners.
As explained above, the production of refined coal is legitimate
business activity that Congress sought to make profitable
through tax incentives, including for partnerships. Without
more, high after-tax profit margins suggest only that the tax
credit is a generous one, not that the entities obtaining them are
something other than a legitimate partnership. In this case, for
example, nobody doubts that AJG could benefit from the tax
credit, no matter how small its investment or how large its tax-
driven profits. Fidelity and Schneider were no less eligible to
reap the rewards of Congress’s generosity.

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We recognize that Fidelity and Schneider could not fairly
be treated as equity partners if their investments in Cross were
so trivial or so insulated from risk as to make them indifferent
to Cross’s success or failure. But as shown above, Fidelity and
Schneider had much skin in the game. Through their initial
investments and contributions to operating expenses, they put
millions of dollars at risk, in amounts proportionate to their
respective ownership interests. Moreover, as the tax court
explained, “it was entirely within the realm of possibility” that
they would not recover much of their capital, A. 1829, in sharp
contrast to the cases cited by the Commissioner, see ASA
Investerings, 201 F.3d at 514–15 (hedge transactions made any
risk of loss “de minimis”); Bank of N.Y. Mellon, 801 F.3d at
122 (transactions amounted to a “circular cash flow”); Reddam,
755 F.3d at 1061 (“tax loss” from transaction “would always
… have overshadowed” any underlying gains or losses). The
tax benefits that the partners received varied entirely with the
amount of coal that Cross was able to refine. And there were
significant downside risks, which materialized for long
periods. For instance, though the best-case forecasts projected
that Fidelity and Schneider would receive $105 million in tax
credits over 10 years, they ended up earning only $14.25
million over four years due to two lengthy shutdowns.
Moreover, the two partners lost $2.9 million and $700,000
respectively on the Jefferies refining facility, which used the
same investment structure as Cross. And it could have been
even worse: Fidelity and Schneider were exposed to
significant litigation and regulatory risks, and they faced the
possibility that the refined coal might not meet emissions
standards and thus not qualify for any tax credits.
A material risk of failing to receive a return on investment
is the essence of every equity stake. Fidelity and Schneider’s
investments in Cross carried that risk, which distinguishes this
case from sham partnerships that guarantee a fixed return to

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one putative partner. The tax court correctly concluded that all
members of Cross shared its profits and losses. See Tower, 327
U.S. at 287.
III
For these reasons, we affirm the tax court’s ruling that
Cross was a bona fide partnership.
So ordered.

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