The recent enactment of the Bipartisan Budget Act of 2018 extended and significantly expanded the existing tax credit for carbon sequestration under Section 45Q of the Internal Revenue Code. Although the Section 45Q credit for carbon sequestration has been available since 2008, the limitations and uncertainty associated with the credit greatly limited its effectiveness in spurring investment in eligible carbon capture equipment. As amended, the new Section 45Q represents a serious attempt by Congress to make the credit more attractive by incorporating a number of industry-favorable changes:
- Increasing the Credit Amount. Eligible carbon capture equipment originally placed in service on or after Feb. 9, 2018, but before Jan. 1, 2024, may now qualify for an increased credit that can be claimed over 12 years. The credit for carbon secured and disposed of, but not used in oil and gas production, increases by linear interpolation from $22.66 per metric ton in 2017, to $50 per metric ton in 2026. For carbon secured and used in a qualified enhanced oil or natural gas recovery project, the credit starts at $12.83 per metric ton in 2017, and increases to $35 per metric ton in 2026. After 2026, the amount of the credit is indexed by inflation. In contrast, the amount of the Section 45Q credit available for existing projects remains as before (with an annual adjustment for inflation): (1) $20 per metric ton for carbon secured and disposed of, but not used in oil and gas production; and (2) $10 per metric ton for carbon secured and used in a qualified enhanced oil or natural gas recovery project. With the increased credit levels for new projects, expect a broader range of potential projects to become economically viable.
- Expanding the Qualifying Uses. Under the old law, the taxpayer needed to either dispose of the carbon in secure geological storage or use it as a tertiary injectant in a qualified enhanced oil or natural gas recovery project. The new law expands upon the eligible uses of captured carbon by allowing the credit to be claimed for carbon removal that stores the carbon in a material or chemical compound, such as cement, or that uses the captured carbon for any other purpose for which a commercial market exists. These new uses qualify for the same dollar credit as the carbon used in a qualified enhanced oil or natural gas recovery project.
- Lowering the Carbon Capture Threshold. For the credit to apply, certain thresholds of carbon capture must be met. The old law required a project to sequester no less than 500,000 metric tons of carbon each year in order to be eligible for the credit. Under the new law, certain facilities that either engage in direct air capture of carbon or use the carbon for one of the new eligible uses discussed above (e.g., storage in chemicals or materials) have lower annual thresholds of required carbon sequestration (e.g., 100,000 metric tons). The lower eligibility thresholds should allow a wider range of industries to participate in the Section 45Q program, as many industry sectors have opportunities to capture and manage their carbon emissions in ways that qualify under Section 45Q.
- Eliminating the Total Program Cap. For qualifying projects placed in service after enactment of the new law, the law eliminates the total program cap that continues to apply with respect to existing projects. Under the old law, the credit was limited to the first 75 million tons of carbon capture claimed by all projects, with credits available only on a first-come, first-served basis. This program cap considerably impeded the appeal of the credit as a project financing source since it was not possible for a developer to know, when planning a project, how much tax credit would be available after the project had been developed. Removal of the program cap for new projects eliminates this uncertainty.
- Increasing Flexibility for Eligible Ownership Structures. Under the old law, only the person who captured and stored (physically or contractually) the carbon could claim the credit. Often, such persons (e.g., municipal utilities and project developers) did not have sufficient tax appetite for the credits. In contrast, under the new law, the person who owns the carbon capture equipment is the recipient of the tax credit and may elect to transfer the credit to a person who disposes of or uses the carbon. This modification greatly expands the ability to accommodate different business models and facilitate the participation of companies that would not otherwise have the ability to utilize the tax credits.
In the coming months, the IRS is expected to issue guidance that will help facilitate and implement these new Section 45Q rules, which provide a meaningful incentive to increase development of carbon capture facilities and should lead to new tax equity transactions.