Carbon Sequestration Tax Credits – IRS Requests Comment on Section 45Q Regulations

May 8, 2019

In February 2018, the tax credit for carbon capture and sequestration under Section 45Q of the Internal Revenue Code (the carbon sequestration credit) received a significant boost from Congress in the Bipartisan Budget Act of 2018 (2018 Budget Act). Now the IRS seeks general comment on specific issues related to the tax credit.

Through the 2018 Budget Act, Congress increased the amount of the credit, removed the volume cap and expanded the group of taxpayers eligible to claim the credit. Congress made these changes to the carbon sequestration credit to promote investment in carbon capture and sequestration projects, particularly by removing a cap that made financial investors leery. For an overview of the expanded Carbon Sequestration Credit following the amendments made in the 2018 Budget Act, see McGuireWoods’ July 2018 alert “New Opportunities Follow Expansion of Section 45Q Carbon Sequestration Credits.”

On May 2, 2019, the IRS released a long-awaited notice seeking general comments on issues arising under Section 45Q that should be addressed in regulations and other guidance. (As provided in the May 2 notice, until the IRS issues additional guidance, Notice 2009-83, 2009-44 I.R.B. 588, modified by Notice 2011-25, 2011-14 I.R.B. 604, provides that taxpayers can rely on pre-2018 Budget Act guidance for purposes of determining eligibility for the carbon sequestration credit.) Several taxpayers previously submitted unprompted comment letters urging the U.S. Department of the Treasury to issue regulatory guidance. The May 2 notice seeks comments on the following specific issues:

  • Secure Geological Storage. One method of qualifying for the credit is to dispose of the captured carbon oxide in “secure geological storage.” The IRS seeks comments on whether there are technical criteria, existing guidelines, standards or regulations that could be used to demonstrate “secure geological storage” that are different from or in addition to those used in the Environmental Protection Agency’s (EPA’s) Greenhouse Gas Reporting Program. The IRS also requests comments on IRS Form 8933 (the form required to be filed by a taxpayer to claim the carbon sequestration credit) and the EPA permits required to be obtained by a qualifying taxpayer in connection with claiming such credits.
  • Beginning Construction. The carbon sequestration credit applies to facilities that begin construction before Jan. 1, 2024. The IRS seeks comments on what constitutes the beginning of construction for purposes of Section 45Q(d). Commenters generally have suggested that Treasury adopt the “begin construction” requirements that currently exist for the production and investment tax credits under Sections 45 and 48 of the Internal Revenue Code.
  • Utilization. “Utilization” of qualified carbon oxide means (i) fixation of the carbon oxide through photosynthesis or chemosynthesis, (ii) chemical conversion of the carbon oxide to a material or chemical compound in which the carbon oxide is securely stored and (iii) use of the carbon oxide for any purposes (other than as a tertiary injectant) for which a commercial market exists, as determined by the Secretary of the Treasury. The IRS seeks comments on whether guidance is required to define these types of utilization. A commenter requested Treasury to include as a qualified utilization the use of carbon oxide as synthetic fuel, including synthetic gasoline and synthetic diesel, that can be blended with fossil fuel-based transportation fuels.
  • Measurement of Utilized Carbon Oxide. For purposes of determining the amount of qualified carbon oxide utilized by the taxpayer, such amount shall be equal to the metric tons of qualified carbon oxide, which the taxpayer demonstrates, based on an analysis of lifecycle greenhouse gas emissions, were (i) captured and permanently isolated from the atmosphere, or (ii) displaced from being emitted into the atmosphere. The IRS seeks comments on what issues may arise when determining the amount of metric tons of qualified carbon oxide utilized by the taxpayer.
  • Recapture. Treasury is required to promulgate regulations that provide for the recapture of the benefit of any credit with respect to any qualified carbon oxide that “ceases to be captured, disposed of or used as a tertiary injectant” in a manner consistent with the requirements of Section 45Q. The IRS seeks comments on what should be the standard for triggering and measuring recapture and how recapture should relate to the requirements of Section 45Q. One early commenter proposed the adoption of a safe harbor, under which taxpayers that adhere to certain requirements for the capture, disposal or use of carbon oxide have limited and more predictable recapture risk.
  • Lifecycle Emissions. The IRS seeks comments on whether guidance is required to establish the boundaries of lifecycle emissions for carbon oxide utilization to determine the amount of qualified carbon oxide that is “displaced from being emitted into the atmosphere.”
  • Contractually Ensures. The person who owns the carbon capture equipment and physically or “contractually ensures” the capture and disposal, utilization or use of the qualified carbon oxide as a tertiary injectant may claim the carbon sequestration credit. The IRS seeks comments on what types of contractual arrangements investors anticipate with parties who capture, dispose or utilize carbon oxide and what terms would be common in such contracts. A commenter previously suggested that any requirements regarding the contract’s enforcement mechanism be sufficiently flexible to accommodate various industry standards.
  • Election. Unless an election is made for equipment that is originally placed in service on or after the date of the 2018 Budget Act, the person who owns the carbon capture equipment, and physically or contractually ensures the capture and disposal, utilization or use as a tertiary injectant of such qualified carbon oxide, qualifies for the carbon sequestration credit. If that person makes an election, in such time and manner as prescribed by Treasury, then the person that disposes of the carbon oxide or utilizes the carbon oxide (including as a tertiary injectant) may claim the carbon sequestration credit. The IRS prompts taxpayers to suggest factors to consider in determining the time and manner of the election to transfer the credit and issues that surround the transfer. One commenter suggested that Treasury permit the partial transfer of the credits, which would allow developers and tax equity investors additional flexibility in structuring projects.
  • Other Definitions. The IRS is considering whether any further guidance is needed to clarify terms and definitions, including carbon capture equipment, qualified carbon oxide, direct air capture facility, qualified facility, tertiary injectant utilization, and lifecycle greenhouse gas emissions. A qualified facility includes an “electricity generating facility” (also undefined in Section 45Q) that captures at least 500,000 metric tons of qualified carbon oxide during the taxpayer year. A commenter previously proposed a definition of electricity generating facility that would require a qualified facility to sell a majority of its electricity on the grid.
  • Tax Equity Structures. The IRS asks whether guidance is needed concerning structures in which project developers and investors would be respected as partners in a partnership generating the credit through carbon capture activities.

Public comments received in response to the May 2 notice are expected to shape future regulations and other guidance implementing Section 45Q. The carbon sequestration credit has the potential to incentivize taxpayers to invest in carbon capture technology and methods to permanently store or use such captured carbon; however, written guidance from Treasury is a necessary step to unlock this potential. Treasury will need to move quickly after it receives comments to complete its guidance, as projects must commence construction by end of 2023 to be eligible to claim the carbon sequestration credit. The IRS will take comments for 45 days beginning on May 20, 2019.

McGuireWoods lawyers are experienced in energy, project finance and tax equity structures. Do not hesitate to reach out if your business would like to participate in this public comment period under Section 45Q.