Advisories January 19, 2021

Federal Tax Advisory: 45Q Regulations Will Spur Carbon Capture and Storage Investment

Executive Summary
Minute Read

Carbon capture and storage could play a major role in a Biden Administration eager to rejoin the Paris Agreement. Our Federal Tax Group provides a brief overview of the 45Q credit and key takeaways from the IRS’s new final regulations.

  • Section 45Q provides a tax credit for captured carbon oxide
  • Final regs favor taxpayers and provide much-needed clarity
  • 5 key takeaways

On January 6, the IRS issued much anticipated final regulations for carbon capture and storage (CCS) under Code Section 45Q. The regulations provide certainty and needed flexibility for project development, and we expect to see a ramp up in CCS projects as a result.

Generally, Section 45Q provides a tax credit for each metric ton of qualified carbon oxide captured at a qualified facility using carbon capture equipment and disposed of, used as a tertiary injectant in enhanced oil recovery (EOR), or otherwise used as described in Section 45Q(f)(5). The amount of such credit depends on whether the taxpayer captures qualified carbon oxide using carbon capture equipment originally placed in service at a qualified facility before February 9, 2018 or on or after February 9, 2018 and whether the carbon oxide is disposed of, injected, or utilized by the taxpayer. For disposal, the credit is $50 per ton of carbon oxide and for EOR the credit is $35 per ton of carbon oxide.

In February 2020, the IRS issued Rev. Proc. 2020-12, which provided a safe harbor framework for structuring tax equity partnerships formed to invest in projects that qualify for the Section 45Q tax credit, and Notice 2020-12, which provided guidance on determining when construction has begun on carbon capture equipment or qualified facilities. This initial guidance was followed by proposed regulations in May 2020 that offered guidance on, among other things, the documentation requirements of sequestration projects, events that trigger credit recapture, and the process of credit recapture in the year that the recapture event occurs.

Despite this initial guidance, questions remained about claiming and documenting the credit and credit recapture. This uncertainty caused reluctance in the energy industry to invest in tax-credit-motivated sequestration projects. However, the final regulations are largely taxpayer favorable and provide clarity in many of the areas that have remained murky since the release of the proposed regulations. Additionally, the final regulations modify previous guidance by extending certain deadlines and making the credit more generous. Below are some key takeaways from the final regulations:

  • Following on the heels of the 2021 Consolidated Appropriations Act, extends the construction start date deadline for qualified facilities and carbon capture equipment through December 31, 2025, which allows an additional two years past the deadline provided in Notice 2020-12 for projects to ramp up.
  • Provides clear rules on the standards for establishing “secure geologic storage,” which for EOR allows reporting under either Subpart RR of the Environmental Protection Agency’s (EPA) Greenhouse Gas Reporting Rule or the International Organization of Standardization (ISO) standard provided in CSA/ANSI ISO 27916:2019. Consistent with EPA regulations, reporting under Subpart RR is required for disposal wells. Taxpayers reporting under Subpart RR can self-certify the amount of carbon oxide stored, while those using the ISO standard must have its calculation verified annually by a qualified third-party engineer or geologist.
  • Limits the recapture period to three years from the date of initial disposal or injection, which is shorter than the five-year lookback period provided for under the proposed regulations. Recapture takes place by reducing the credit allowable in the year of carbon oxide leakage or increases tax due to the extent that the leakage exceeds the credit received in such year. This shorter recapture period should generally reduce overall project risk.
  • Provides further clarification of the “single project” rule under Notice 2020-12 that allows for aggregation by a taxpayer of several smaller carbon capture facilities into one project for purposes of claiming the credit when certain factors are present, such as common ownership and location. This opens the door for new industry players in CCS, such as landfills.
  • Allows the owner of the carbon capture equipment to make a “transfer election,” which allows the Section 45Q credit to be claimed by the party that disposes, injects, or utilizes the qualified carbon oxide.

The regulations are expected to spur private investment in CCS projects. Widespread support for CCS is expected from the incoming Biden Administration, including at the Department of Energy and EPA, because CCS will play a key role in meeting greenhouse gas reduction targets under Biden’s climate plan and the Paris Agreement, which the President-elect says he will rejoin on day one of his presidency.

For more information, please contact Scott Harty at 404.881.7867, Elise Paeffgen at 202.239.3939, or April McLeod at 212.210.9487.

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