In 2018, Congress revamped a tax credit available under section 45Q of the Internal Revenue Code (IRC) for companies that capture and sequester carbon dioxide (or other carbon oxides). On February 19, 2020, the Internal Revenue Service (IRS) issued two highly anticipated items of guidance under IRC section 45Q that provide certainty regarding a number of questions left open by the statute; a further item of guidance is expected that should answer many of the remaining open questions.
Companies that emit carbon dioxide or other carbon oxides (collectively referred to as qualified carbon oxide in the statute) may benefit from capturing and sequestering such emissions and claiming or monetizing the tax credit, or by selling those emissions to a person that will undertake the capture and sequester activities for which the credit is available.
The revamped section 45Q credit has generated significant interest from both parties that emit carbon as part of their manufacturing processes and from potential investors in carbon capture and sequestration (CCS) projects. In fact, about 110 comment letters were submitted to the IRS regarding guidance under IRC section 45Q. That is the case because CCS projects have the potential to generate significant value for emitters and investors. For example, capturing 500,000 metric tons of carbon oxide per year could yield over $260,000,000 in tax credits over 12 years, and the actual amount the credit may be multiples of that amount depending on the volume of qualified carbon oxide captured and sequestered.
The general requirements for the tax credit are as follows: IRC section 45Q provides a tax credit to taxpayers that capture and sequester carbon oxide. Such tax credits are available for a period of 12 years and, to be entitled to the credit, the taxpayer must (i) dispose of captured qualified carbon oxide in secure geological storage, (ii) use captured qualified carbon oxide as a tertiary injectant in a qualified enhanced oil or natural gas recovery project and dispose of it in secure geological storage, or (iii) utilize captured qualified carbon oxide for certain other purposes as permitted by statute or regulation. IRC section 45Q requires that construction on a CCS project begin before January 1, 2024 in order to be eligible for the tax credit. IRS Notice 2020-12 addresses how to qualify as having begun construction.
The tax credits are generally attributed to the owner of the equipment that captures the carbon. However, the tax credits are transferable to investors through certain “tax equity” structures. Revenue Procedure 2020-12 addresses how developers of CCS projects and investors can use a “partnership flip structure” for CCS projects that generate section 45Q credits for use by investors.
The market has generally reacted well to the revamped IRC section 45Q and the recent guidance. Such guidance, together with forthcoming guidance that should address the remaining open issues, is expected to result in the flow of significant capital for development of CCS projects.
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Who can claim section 45Q tax credits? The owner of the equipment that captures qualified carbon oxide or, by election, the person that disposes of the qualified carbon oxide. One of the two recently issued items of guidance, IRS Revenue Procedure 2020-12, provides guidance to help companies that do not have sufficient tax liability to utilize IRC section 45Q tax credits monetize those credits through a partnership flip structure that utilizes investors that have sufficient tax liability.
What activities generate credits? Tax credits are available for three different uses of captured qualified carbon oxide: (i) disposal in secure geological storage, (ii) use as a tertiary injectant in a qualified enhanced oil or natural gas recovery project and disposal in secure geological storage, and (iii) utilization as permitted by statute or regulation. Credit amounts vary by activity but range from $20 to over $50 per metric ton.
When can tax credits be claimed? Tax credits are available for a 12-year period that starts once the carbon capture equipment is placed in service. Construction of the project must begin by the end of 2023. The other item of recently issued guidance, IRS Notice 2020-12, provides rules when construction is treated as begun (which is a relatively low bar under that guidance).
Why is the new section 45Q credit and new guidance significant? The new section 45Q credit fixed many of the issues with the prior credit and now is attractive to emitters of carbon dioxide and other carbon oxides. The new guidance provides some additional certainty regarding the rules for obtaining and monetizing the section 45Q tax credits.
Where to learn more? For additional coverage, see our guide to the newly issued section 45Q guidance.