According to the Center for Climate and Energy Solutions, “23% of U.S. greenhouse gas emissions come directly from industrial sources, such as manufacturing, food processing, mining and construction.” Many large investment firms and corporate conglomerates, as a result, have adopted policies that focus on Environmental, Social and Governance issues (ESG) as part of their core values. These investment firms and publicly traded corporations will likely expect business partners throughout their supply chain to also adopt sustainable practices, such as reducing carbon emissions.
Take a look at some examples of larger businesses adopting sustainable practices, according to the companies’ websites: Illinois Tool Works has set a greenhouse gas emissions intensity reduction target of 40% by 2030 (using 2017 as a baseline year). John Deere, too, has pledged to reduce greenhouse gas emissions by 15 to 50% with its renewable electricity supply and energy efficiency.
Fortunately for middle-market manufacturing and distribution companies with a desire to reduce their carbon footprint, certain tax incentives are available (or could become available) to offset the sizable investments they must make.
Current Law
Energy Improvement and Extension Act: A credit for CO2 sequestration was first introduced to the tax code by the Energy Improvement and Extension Act of 2008. The legislation included several provisions specifically designed to encourage a cleaner, more efficient and environmentally responsible use of coal. It also focused heavily on reducing greenhouse gas emissions.
Bipartisan Budget Act: The Bipartisan Budget Act of 2018 extended and expanded the Section 45Q tax credit to include a larger credit amount, enhancements to the start-of-construction deadline and a 12-year claim period instead of the 75 million metric ton cap. The new law also established a credit for CO2 utilization, in addition to the existing Enhanced Oil Recovery (EOR) credit and Direct Air Credit (DAC). Further, it allowed smaller facilities and owners of carbon capture equipment to claim the credit (instead of the person capturing the CO2). This change created flexibility in ownership structures facilitating tax-equity investment.
The tax credit for carbon oxide sequestration under Section 45Q is computed on a per metric ton of qualified carbon oxide captured and sequestered. The amount of the credit, as well as various features of the credit, depend on when the qualifying capture equipment is placed in service. For purposes of this credit, “qualified carbon oxide” is a carbon oxide that would have been released into the atmosphere if not for the qualifying equipment. To claim this tax credit, the emissions must be measured at the point of capture and the point of disposal, injection or other use.
Consolidated Appropriations Act: The Consolidated Appropriations Act, 2021 extended the deadline to begin construction to January 1, 2026.
Rev Proc 2020-12 and Notice 2020-12: In addition, the IRS issued final regulations in January 2021 for claiming the Section 45Q credit. Among the issues addressed in these regulations were requirements for “secure geological storage,” credit recapture and taxpayers eligible to claim the credit. The IRS also issued guidance in 2020 in the form of Rev Proc 2020-12 and Notice 2020-12.
If captured carbon oxide is intended to be sequestered, it must be disposed of in “secure geological storage.” Section 45Q describes secure geological storage to include “storage at deep saline formations, oil and gas reservoirs, and unmixable coal seams.” The taxpayer must repay the tax credit (credit recapture) to the IRS if the carbon oxide ceases to be captured, disposed of or used in a qualifying manner (i.e., if it escapes into the atmosphere).
Carbon Capture, Utilization and Storage: The International Energy Agency states that there are currently 21 large-scale Carbon Capture, Utilization and Storage (“CCUS”) commercial projects where carbon dioxide is taken out of factory emissions internationally.
The volume of carbon captures each year must meet certain thresholds to qualify for the credit. The required volume ranges between 100,000 and 500,000 metric tons each year, depending on the usage of the captured CO2. The credit amounts also increase each year. In 2022, each ton of CO2 captured and put into secure geological storage earns a credit of $37.85. If the CO2 is put to a permitted commercial use, the credit is $25.15 per ton. The credit is earned by the company or person that owns the carbon capture equipment and disposes of the CO2, and it can also be transferred to a separate entity that disposes of the CO2.
Infrastructure Investment and Jobs Act: The recently passed Infrastructure Investment and Jobs Act (enacted in November 2021) offers tax-exempt bond status to private activity bonds issued after December 31, 2021, specifically for qualified carbon dioxide capture facilities. Qualifying uses of bond proceeds include eligible components of an industrial carbon dioxide facility or a facility defined in Section 45Q. Eligible components are components that convert processing by-products into other uses, ultimately reducing the emission of CO2 from those by-products.
Recent Legislative Proposals
In 2021, we saw many different legislative proposals to both expand and reduce tax credits for carbon sequestration. Some clean energy provisions that were proposed under the Build Back Better (BBB) legislation now remain stalled in Congress (more on that below). While there are some members of Congress who see these provisions as corporate welfare, most support tax credits to reduce greenhouse gas emissions.
Mentioned above, the 45Q Carbon Capture, Utilization and Storage (CCUS) Tax Credit Amendments Act of 2021 (which was reintroduced in the BBB) includes the following key provisions, per research from the Columbia Climate School:
- Extending the date for projects to qualify for the 45Q tax credit by an additional five years – projects that begin construction by the end of 2030 would qualify.
- Creating a direct-pay option for the Section 45Q and Section 48A tax credits – the direct-pay option allows developers to treat credits as an overpayment of taxes so that the credit is recovered in the company’s tax returns.
- Increasing the value of the 45Q tax credit for direct air capture of CO2 – from $50 to $120 per metric ton for facilities that capture and store CO2 in saline formations; and from $35 to $75 per ton for such facilities that store CO2 via enhanced oil recovery.
- Allowing existing power and industrial carbon capture facilities to combine the Section 48A investment tax credit with the Section 45Q tax credit to finance CCUS retrofits.
Several other legislative proposals landed on a value of $85 per metric ton for capture and storage of CO2, and there is bi-partisan support around this target.
Section 48C Credit: Another proposal that became part of the BBB legislation was expanding the Section 48C credits. This would allow companies to qualify for a 30% tax credit on the cost of the investment to build or expand operations, including machinery used for the manufacturing of components used in or the final assembly of renewable or advanced clean energy technologies.
The credits would apply to projects, such as:
- Renewable energy technology (solar, wind, hydro and geothermal);
- Energy storage technologies (fuel cells and micro-turbines);
- Advanced transmission technologies that support renewable generation; and
- Renewable fuel-refining or blending technologies.
This proposal would benefit certain producers and manufacturers of green technologies. There is still some optimism for legislation in 2022, even if the BBB legislation fails, that will enhance tax credits for carbon sequestration and overall clean energy.
Other Energy Tax Incentives
For manufacturers that are expanding or improving their current facilities, the Section 179D commercial building energy efficiency tax deduction allows a deduction of up to $1.80 per square foot for installing: (1) interior lighting; (2) a building envelope; or (3) heating, cooling, ventilation or hot water systems that reduce the energy and power cost of the interior lighting, HVAC and service hot water systems by 50% or more in comparison to a building meeting minimum requirements set by ASHRAE Standard 90.1. If the manufacturer leases the building, they may still be eligible when making improvements.
Key Takeaways
Carbon sequestration and clean energy initiatives appear to have the support of many members of Congress and also many large and influential corporations. For middle-market manufacturers and distributors, there are uncertainties as to the true cost of investing in infrastructure that reduces their carbon footprint. It has been reported that a significant amount of carbon credits reported under Section 45Q have been disallowed due to EPA regulatory non-compliance. Thus, additional tax incentives may be needed for clarification of these incentives and to encourage business investment.
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About our authors
Tom Bayer
Thomas Bayer, CPA, CExP, has 30 years of experience providing a broad range of accounting, tax and business advisory services to commercial clients across various industries. Tom has specialized expertise in the areas of tax planning and compliance, business advisory services and business succession planning.
Jim Brandenburg
Jim Brandenburg, CPA, has extensive experience and knowledge in corporate and partnership tax law, mergers and acquisitions and tax legislation. His expertise includes working with owners of closely held businesses to identify tax planning opportunities and assist them in implementing these strategies.
