IRS Rules for 45Q Tax Credit Clear Path for US Carbon Capture Projects

IRS Rules for 45Q Tax Credit Clear Path for US Carbon Capture Projects

At New Energy Risk, we’re excited about carbon capture technology, which is critical for hard-to-decarbonize industrial infrastructure. For carbon capture to continue to iterate and improve, it needs non-recourse project financing and the traditionally conservative tax equity community to come to the table. Tax equity is critical for monetizing the US federal tax credits like 45Q.

45Q is available for 12 years to incentivize carbon capture technology deployment for utilization, enhanced oil recovery, and geologic sequestration. To help attract tax equity, NER’s technology risk performance insurance solutions are a critical part of the desirable financial infrastructure. NER’s solutions are specifically tailored to the needs of carbon capture to address concerns about technology performance, credit recapture, and financial responsibility for geologic storage.

As we’ve talked with project developers, we’ve noted that 45Q has presented almost as many questions as answers, which has lead to project paralysis.

Luckily, as of May 28, the IRS has finally provided responses to many project developers’ longstanding uncertainties surrounding 45Q, so that these projects can proceed with the required certainty to make use of the 45Q tax credit.

In the rest of this article, we’ll summarize the key takeaways of that update and get a bit into the weeds.

45Q Reform and Updates as of Early 2020

45Q was reformed in 2018, increasing its value and removing a limit on the number of credits available, which had created uncertainty and stifled the utilization of the credit. Congress left many details to be determined by the IRS in a rulemaking process, which the IRS opened to the public in Notice 2019–32.

During this rulemaking, the clock was already ticking since the reformed 45Q statute includes a Commence Construction deadline of January 1, 2024. The carbon capture community was stuck in a catch-22: rushing to meet the construction deadline while lacking clarity on how the tax credit would be implemented. Then earlier this year, the IRS issued two guidance documents, Notice 2020–12 and Revenue Procedure (RP) 2020–12, which addressed a few of the many outstanding questions left by Congress on how to implement 45Q.

Notice 2020–12 included:

  • Definition of ‘Commence Construction’ to include both ‘Physical Work Test’ and ‘5% Safe Harbor’ pathways, analogous to other renewables tax credits
  • Allowance of a safe harbor for a continuous construction period of six years, which compares favorably to the four years for wind and solar

The RP 2020–12 included details about permissible partnership structures, including that the partnership does not need to generate cash revenues. Normally, business transactions may not be completed solely for the purpose of a tax benefit. However, in the case of carbon capture with geologic storage, the only revenue is the 45Q tax credit. Importantly RP 2020–12 explicitly allows for insurance (like New Energy Risk’s solutions) to be used to ultimately mitigate investor risks.

So, What Just Happened?

On May 28, 2020, the IRS issued REG-112339–19, which finally answers all of the major remaining questions:

  • Recapture of tax credits in the event of CO2 The recapture period begins with the first injection of CO2 for geologic disposal and ends five years after the last claim of a 45Q credit or when monitoring ends, whichever comes first. Recapture will operate on a last-in/first-out basis beginning in the current tax year. For storage sites supplied by multiple projects, the leakage is allocated on a pro-rata basis. The guidance explicitly allows for recapture insurance (which New Energy Risk could support).
  • Credit transfer is a unique aspect of 45Q that allows the capture equipment owner to elect to transfer the credits to other taxpayers within the carbon capture partnership. Credit transfer is complementary to tax equity investors, allowing 45Q credits to be allocated to project partners with tax liability or to be monetized by conventional tax equity investors. The IRS allows for an election each tax year for all or a portion of the tax credits to be assigned to one or several claimants.
  • Protocol for carbon accounting for utilization. The IRS requires a lifecycle assessment (LCA) by a licensed, third-party firm consistent with ISO 14044:2006 standards. The LCA must account for all greenhouse gases, which means that carbon utilization projects can use 45Q to monetize savings in both CO2 and other, more potent greenhouse gases.
  • Protocol for secure geologic storage. It’s important that CO2 stored underground stay there. Two types of wells can be used to accomplish this. Class VI wells, used only for CO2 storage, already require compliance with an EPA regulation called Subpart RR, and that reporting will be accepted by the IRS. The IRS decision to accept EPA reporting saves work for project operators. The other type of well, called Class II, is used in enhanced oil recovery. Operators may opt into reporting to the EPA under Subpart RR or use a new international standard for CO2 storage, the ISO 27916:19 standard. However, state and tribal reporting will not be accepted.

The rule also helpfully and expansively defines ‘Carbon Capture Equipment’ broadly to include all the equipment used for capture, treatment, and preparation of the carbon oxides, but excludes the transportation and disposal/injection/utilization equipment. The rule also defines a ‘Qualified Facility’ in the context of industrial sites where some equipment is pre-existing. The IRS applied the 80/20 rule, whereby the site qualifies if 80%+ of the capital equipment is new.

As more carbon capture projects start up, aided in part by 45Q and the IRS’s new guidelines, we’re very excited to see the industry advance through proof of performance and scale. To get there, NER can play a key role in supporting project financing. If you’re involved in a carbon capture project and we haven’t spoken yet, please give us a call so we can discuss opportunities to partner.

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Originally published at https://newenergyrisk.com on June 3, 2020.

New Energy Risk helps insure technical risk for breakthrough tech to optimize cost of capital, accelerate time to market, and provide certainty of execution.

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