Monetizing the Section 45Q Tax Credit: The Key to Carbon Sequestration | Baker


[co-author: Michael Palmer*]

Whether there is to be rapid progress in limiting the increase of carbon dioxide (CO2) in the atmosphere, this will largely depend on federal tax credits and state incentives for carbon capture and storage. . So far, carbon capture and storage strategies are largely of three types: (1) biological removal (using photosynthesis to fix atmospheric CO2 in soils, grasses and trees), (2) direct air capture (DAC) (by removing atmospheric CO2 and injecting it into geological formations), and (3) capturing CO2 before it is released. All three forms of capture may be eligible for a tax credit under Section 45Q of the United States Internal Revenue Code.

On July 1, 2021, the IRS issued Revenue Ruling 2021-13 (Rul. Rev. 2021-13). In the relevant part, this decision ruled that an investor must own at least one component (and is not necessarily required to own all components) of the carbon capture equipment in the “single process train” of carbon capture equipment at a facility in order to claim a Section 45Q Tax Credit.

Will the decision facilitate the monetization of the section 45Q tax credit?

By allowing the Section 45Q tax credit to be shared among owners of major pieces of equipment used to capture and store carbon monoxide, the ruling gives more flexibility to project developers and investors.

The “flip partnership” should be the preferred transaction structure in the Section 45Q tax fairness market, as the cost of industrial scale carbon capture equipment decreases.[1] Partnership rollover structures allow developers to monetize credit by allocating it to tax capital investors who have sufficient income to use the credits generated. Typically, a developer seeks tax equity investors and forms a project company, usually in the form of a limited liability company, to own and operate a credit-generating asset. The project company is taxed as a partnership, which allows tax attributes and cash distributions to be flexibly allocated between developer and investors. Initially, most taxable income, losses and section 45Q tax credits are allocated to investors. But once investors hit a target rate of return, the tax and cash allocations “reverse” and most of the remaining Section 45Q taxable income, losses, and tax credits are allocated to the developer.

For the purposes of the article 45Q tax credit, the credit generating asset is the carbon capture equipment. For equipment commissioned from February 9, 2018, the developer is the entity that owns the equipment and physically or contractually ensures the sequestration of the captured carbon monoxide.[2] The “contractually insured” language allows developers to contract or subcontract the removal, injection or use of carbon monoxide and continue to claim the tax credit, provided certain conditions are met. fulfilled.[3] Developers can also make an election under section 45Q (f) (3) (B) to allow a contractor who removes, injects, or uses the qualified carbon monoxide to claim the credit, in effect transferring the credit. The flexibility and portability of the credit ensures that developers and investors will be able to design flexible partnership structures or other arrangements to optimally allocate Section 45Q tax credits to parties who can use them. .

Under Reverend Rul. 2021-13, additional help claiming the credit has been provided to developers and others by the IRS, stating that at least one component (and not all components) of a single process train must belong to a single developer and providing useful advice on how to calculate the commissioning date for the purposes of the section 45Q tax credit when the same process train includes several components, each of which is commissioned at different times. different.

* BakerHostetler thanks Michael Palmer, a second year student at Northwestern University Pritzker School of Law, for his research and writing support.


[1] To encourage hesitant investors, the IRS has established a safe harbor for partnership transactions in the 2020-12 tax process. In this guide, the IRS explains how tax partnerships used in Section 45Q transactions can properly allocate credit in accordance with the tax rules applicable to partnerships and under what conditions investors will be considered bona fide partners. The procedure also provides an example of a qualifying partnership structure under section 45Q, which is substantially similar to the typical partnership rollover structure described above, with a 99% and 1% split on tax allowances for individuals. investors and the developer, respectively, and a 5 percent and 95 percent split after the turnaround. Given its flexibility and the directions of the IRS, the partnership turnaround structure should be the common monetization structure of the section 45Q tax credit.

[2] Treas. Reg. § 1.45Q-1 (h) (1) (ii).

[3] Treas. Reg. §§ 1.45Q-1 (h) (1) (ii), (h) (2).

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