Carbon Capture, Utilization and Sequestration Tax Benefits under the Proposed Inflation Reduction Act

The Act also contains a variety of beneficial modifications to existing tax credits aimed at propping up the developing CCUS industry and appears to be responsive to industry and policy suggestions that will allow for meaningful development of CCUS projects, broaden the number of CCUS-related projects that can benefit from these tax credits and potentially increase the number and character of CCUS industry participants.

CCUS is the process of injecting carbon oxides into underground geological formations for permanent storage to be trapped or transformed as opposed to being emitted into the atmosphere. CCUS has gained momentum in recent years as a manner by which carbon emissions may be limited in an effort to combat climate change. The US government has supported this effort by providing certain tax credits to owners and developers of CCUS projects, often referred to as “45Q” tax credits in reference to the Internal Revenue Code section that provides for these credits.

45Q tax credits are currently based on the amount of carbon oxides captured and sequestered, calculated by the metric ton. For projects with carbon capture equipment placed in service on or after February 9, 2018, these tax credits will accrue to the person or entity who owns the capture equipment and physically or contractually provides for the disposal or utilization of the carbon oxides. (The value of the existing 45Q tax credit is about $50 per ton of stored carbon oxide.)

A DEEPER DIVE

The Act contains several important broadening changes to the 45Q tax credit, all of which are intended to help spur CCUS project and technological development, with the ultimate goal of facilitating a self-sustaining, market-driven CCUS industry.

• Increase in Tax Credit Value to $85 per Ton. The Act increases the value of the 45Q tax credit for carbon oxide geological sequestration to $85 per ton (up from the current $50 per ton). Clean air policy advocates have argued that $85 per ton is a threshold tax credit value to incentivize hard-to-abate industrial businesses, such as petrochemicals, cement, steel and refineries, to incorporate CCUS into their facilities and receive ample benefit from the tax credit to justify the necessary capital outlay to develop CCUS facilities. The Act also extends the tax credit so that it is available for projects beginning construction before 2033.

• Added Tax Credit Value for Direct Air Capture. The CCUS industry also includes emerging technologies to capture CO₂ that is already present in the atmosphere. The Act contains a special rule for DAC facilities under which the 45Q tax credit is valued at approximately $180 per ton, as opposed to the $85 per ton for carbon oxide geological sequestration. Because most DAC technologies in today’s market are early stage or experimental in nature, the additional increase in 45Q tax credits for DAC facilities is aimed at creating synthetic economics for these projects to allow them to receive additional capital to help develop DAC technologies at scale and eventually make DAC businesses widespread and profitable.

• Decrease the Size (Emissions Eligibility Thresholds) of Qualifying Projects. Under the current 45Q tax credit regime, only some of the United States’ largest carbon emitting projects qualify for 45Q eligibility: Power plants must emit more than 500,000 tons per year; industrial facilities must emit more than 100,000 tons per year; and DAC facilities must capture at least 100,000 tons per year. The Act modifies the definition of “Qualified Facility” to lower these thresholds to 18,750 for power plants; 12,500 for industrial facilities and 1,000 tons of carbon oxide captured per year for DAC facilities. These lower thresholds will significantly broaden the universe of projects that can economically benefit from 45Q tax credits, potentially expanding the adoption of CCUS and enhancing its prevalence. Notably, these lower thresholds will likely allow for many fossil fuel-based energy generation facilities to be eligible for 45Q tax credits by implementing CCUS.

• 45Q Tax Credit through Direct Pay. Direct pay, or the ability of the applicable taxpayer to claim the value of the 45Q tax credit through a tax refund as if it were an overpayment of taxes, has long been prophesied as the fundamental missing piece required for CCUS to garner sufficient investment capital to throttle project development forward to significant scale. The logic being that by receiving the 45Q tax benefits in the form of direct pay, project developers and sponsors will avoid the overly burdensome (and often costly) process of raising tax equity to utilize the traditional tax credits generated through 45Q. Direct pay will, theoretically, allow for project developers and sponsors to reap more of the benefits of the 45Q tax credit instead of having to share or transfer those benefits to financial institutions with significant tax appetites. Under the Act, the 45Q tax credit would also be eligible, in the alternative, for transfer to unrelated persons in a non-taxable cash sale, which is another route that could simplify and reduce the costs associated with developing CCUS.

Reading these proposed revisions together, it is clear that one of the goals of the Act is for the US government to spur the growth of CCUS by encouraging additional investment and wider application and adoption. Even if the dollar values and threshold numbers in the Act are not spot on from an industry perspective, they should allow for clearer modeling of CCUS project development budgets and returns and, with direct pay and tax credit transferability, increased liquidity options. At a time when investment dollars are eager to participate in renewable energy and energy transition businesses, these revisions to the 45Q tax credit are likely to help the CCUS industry attract significant capital investment.

The Act remains under review by the US Senate’s chamber parliamentarian, but a vote by the Senate is expected in August 2022. Any tax credits included in the Act will take time to go into effect, and the trickle-down impacts will take even more time, however, an approved and enforceable version of the Act will provide much-needed clarity for project developers, investors and lenders active in the renewable energy and energy transition space and foster further investment in CCUS.

McDermott’s CCUS team and Tax Practice Group are working on several leading CCUS transactions and policy considerations. Please don’t hesitate to reach out to your regular McDermott lawyer or the authors of this article with any related questions or if you would like to discuss potential CCUS transactions or general market activity.