January 27, 2021
Final IRC Section 45Q regulations on carbon oxide sequestration clarify requirements, reduce recapture period
The final regulations (TD 9944) on the credit under IRC Section 45Q for carbon oxide sequestration reduce the recapture period to three years, while retaining the basic approach of the proposed regulations (see Tax Alert 2020-1515).
The final regulations address (1) secure geological storage, (2) contracting with third parties for the disposal, injection, or utilization of qualified carbon oxides and allowing third parties to claim the IRC Section 45Q credits, (3) the definition of the recapture period for carbon oxides that are not properly captured, and (4) clarification on "utilization" of captured carbon.
The final regulations are effective upon publication in the Federal Register.
IRC Section 45Q credits can be claimed for any industrial or direct air-capture facility for which construction begins before January 1, 2026, and that captures certain amounts of qualified carbon oxide, depending on its size.
The Bipartisan Budget Agreement (BBA) created two new credits for carbon oxide captured using equipment originally placed in service on or after February 9, 2018, allowing up to:
In February 2020, the IRS released Notice 2020-12, addressing how to determine when construction has begun on a qualified facility or on carbon capture equipment that may be eligible for the IRC Section 45Q credit. In Revenue Procedure 2020-12, released the same day, the IRS established a safe harbor under which the IRS will treat partnerships as properly allocating the IRC Section 45Q credit (see Tax Alert 2020-0432).
In June 2020, the IRS released proposed regulations (REG-112339-19) laying out the requirements for claiming and reporting IRC Section 45Q credits for persons that (1) qualify for the credit by physically or contractually capturing and disposing of qualified carbon oxide, (2) use qualified carbon oxide as a tertiary injectant in a qualified enhanced oil or natural gas recovery project or (3) utilize qualified carbon oxide (Tax Alert 2020-1515).
Definition of recapture period
The IRS may "recapture" the IRC Section 45Q credit allowed for qualified carbon oxide that ceases to be properly captured, disposed of or used as a tertiary injectant.
The final regulations changed the proposed regulations' recapture period from five years to three years because it "sufficiently accounts for risk and reduces the compliance burden that would be imposed by a five-year recapture period." Accordingly, under the final regulations, the recapture period would:
Any recapture amount will be accounted for in the tax year that it is identified and reported.
If qualified carbon oxide has leaked into the atmosphere, the final regulations specify that the recapture amount is the leaked amount of qualified carbon oxide that exceeds the amount of qualified carbon dioxide disposed in secure geological storage or used as a tertiary injectant in that tax year. That excess amount will be recaptured at a credit rate calculated on a last-in first-out (LIFO) basis (the excess leaked qualified carbon oxide will be deemed attributable first to the first preceding year, then to the second preceding year, and then the third preceding year). The taxpayer must then add the amount of the recaptured IRC Section 45Q tax credit to the amount of tax due in the tax year in which the recapture event occurs.
As in the proposed regulations, under the final regulations, recapture amounts and credits are allocated pro rata when multiple parties own the carbon recapture equipment or claim the credits. If multiple parties own the carbon capture equipment in one location, the recapture amount is allocated among the taxpayers that own the equipment pro rata, based on the amount of qualified carbon oxide captured from each owner's equipment. Similarly, if the leaked amount of qualified carbon oxide were deemed attributable to qualified carbon oxide for which multiple taxpayers claimed IRC Section 45Q credits, the recapture amount is allocated on a pro-rata basis among those taxpayers.
In addition, a recapture event occurs in the year in which qualified carbon oxide is removed from its original storage if it is deliberately removed from that site.
The final regulations reflect the proposed regulations by allowing an exception for leakage from actions unrelated to the selection, operation, or maintenance of the storage facility in the case of volcanic activity or a terrorist attack but does not expand on these exceptions.
Secure geological storage
IRC Section 45Q(f)(2) requires using EPA standards to establish regulations for determining adequate security measures for the geological storage of qualified carbon oxide so it does not escape into the atmosphere.
The final regulations maintained the proposed regulations' requirement that operators that inject carbon dioxide underground as part of the enhanced oil recovery process are subject to the EPA requirements. The final regulations allow the standard adopted by the International Organization for Standardization (ISO) and endorsed by the American National Standards Institute (ANSI) (CSA/ANSI ISO 27916:19) as an alternative to the EPA standard for enhanced oil recovery but does not allow standards set by the states.
Contracts for disposal, injection or utilization of carbon oxide
The final regulations allow taxpayers to enter into multiple contracts with multiple parties for the disposal, injection or utilization of qualified carbon oxide — the contracts can be with different parties for different methods. The contracts must be written and binding and include commercially reasonable terms of enforcement. According to the final regulations' preamble, they "harmonize the conflicting provisions regarding liquidated damages by replacing the definition of binding written contract in [Section] 1.45Q-1(h)(2)(i) of the proposed regulations with the definition of binding written contract in section 8.02(1) of Notice 2020-12 and [Treas. Reg. Section] 1.168(k)-1(b)(4)(ii)(A)-(D)."
The contracts must be reported to the IRS annually on Form 8933, Carbon Oxide Sequestration Credit. In addition, the party that contracts with the taxpayer claiming the IRC Section 45Q credit must give that taxpayer a copy of its Form 8933. The taxpayer claiming the IRC Section 45Q credit must attach that Form 8933 to its own signed Form 8933.
Under the final regulations, if a taxpayer does not claim the credit in the appropriate tax year , the taxpayer will not be able to claim the credit for any qualified carbon oxide that is disposed of, injected, or utilized in that tax year pursuant to that particular contract.
Election of credits
Eligible parties may designate someone to elect to the claim the credits, as well as the time and manner of those elections. The elections must be made annually on a federal income tax return, not an amended return (except from February 9, 2018 through the date of publication of the final regulations). Both parties to the election must file Form 8933, Carbon Oxide Sequestration Credit.
The elections may be made for all or a portion of the available IRC Section 45Q credit and may be made for a single or multiple credit claimants, with the maximum amount of credits allowable to each credit claimant proportional to the amount of qualified carbon oxide disposed of, utilized, or used as a tertiary injectant by the credit claimant. The final regulations clarified that a subcontractor performing these actions cannot claim the credit.
Utilization of carbon oxide
The final regulations require taxpayers utilizing the carbon oxides for qualified uses to submit a written lifecycle analysis (LCA) consistent with ISO 14044:2006 (Environmental management — Life cycle assessment — Requirements and Guidelines). The LCA must be either performed or verified by a professionally licensed third party. The IRS said in the final regulations that it would publish separate guidance on how often the third-party preparation or verification must occur.
The IRS said in the final regulations that the Department of Energy will conduct a technical review of each LCA, and the IRS will determine whether to approve the LCA and will then notify the taxpayer. The IRS said it will issue separate guidance with additional details about the LCA submission and review process, including the length of time necessary for an LCA review. The IRS declined to adopt a commenter's suggestion that taxpayers be allowed to claim the IRC Section 45Q credit while an LCA is under review.
The final regulations have clearly been crafted with an eye toward industry practices and market realities. While helpful, however, this clarity will not necessarily trigger the development of numerous 45Q projects: the related technologies are nascent in many cases and certain external factors, such as the price of oil, can make it difficult for projects to pencil out except in situations with especially favorable circumstances. Stakeholders will likely continue to consider 45Q as one of the many tools available in pursuit of sustainable industry, but its facets, paired with market conditions, may prevent it in the near-term for being a standalone solution to the successful execution of carbon capture projects.