Carbon Sequestration Tax Credits: Section 45Q

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When the Bipartisan Budget Act of 2018 was passed into law, it expanded the §45Q2 tax credit, an important federal incentive encouraging private investment in the development and use of carbon capture technologies and facilities. Tax credits for the capture and long-term, permanent storage of carbon oxides are intended to generate a competitive financial return and have a positive environmental impact. Reducing CO2 emissions mitigates climate change and helps mitigate the increase in global average temperature to well below 2°C above preindustrial levels. Keeping global average temperature below 2°C above preindustrial levels is a fundamental goal of the Paris Climate Agreement, the highest priority environmental, social, and governance (ESG) issue facing investors.

When applied, a tax credit reduces a company’s tax liability dollar for dollar. The U.S. government uses tax credits to incentivize certain types of projects that produce economic, environmental, or social benefits. Common tax credit programs include affordable housing, rehabilitation of historic properties, and low-income census tract economic development; these migrated to applications for wind energy, solar energy, other renewable energy sources, and now, carbon sequestration projects. For these projects, the tax credit is an important source of capital, but many project developers do not have enough taxable income to take advantage of the tax credits themselves.

In such cases, a project developer may monetize the tax credit by attracting a tax equity investor or group of investors, usually a corporate tax-paying project partner or partners. Tax equity is a term used to describe an equity ownership interest in a qualified project where an investor receives a return based not only on project cash flows but also on tax benefits. With such a transaction, a partnership is typically formed between the project developer and the tax equity investor to not only facilitate the investment but also to allocate and distribute the corresponding tax benefits (credits and depreciation) and project cash flows. The specifics of each partnership vary by project, tax credit type, and transaction structure. In practice, a tax equity investment uses the same dollars that are earmarked to satisfy a company’s tax liability. Those funds are repurposed and then invested into qualified projects that generate tax credits, such as a solar photovoltaic power plant, an affordable housing project, or in this instance, a carbon sequestration project. The tax benefits generated from the project flow back to the investor, offsetting a corresponding amount of tax liability.

A Section 45Q tax credit is a key part of the U.S. government’s effort to mitigate CO2 emissions. It is a bipartisan acknowledgment and recognition of the need to address climate change and the role carbon capture sequestration (CCS) plays as a solution. Democrats and Republicans, fossil fuel companies, unions, and environmentalists have supported Section 45Q tax credits expansion as an investable program—one that benefits the environment and creates economic opportunities through the development, construction, and ongoing utilization of these technologies.

This update is related to a co-authored piece titled “Tax Credit Incentives for Carbon Sequestration: Potentially the Most Impactful U.S. Policy to Battle Climate Change” by Bryen Alperin, Gary Blitz, Sarah Grey, Steve Whittaker, John Koenig, John Pierce, and Jason Kuzma. The aforementioned article was published in Bloomberg Law in May 2021 and adapted with permission. Copyright 2021 The Bureau of National Affairs, Inc. 800.372.1033. For further use, please visit http://www.bna.com/copyright-permission-request/.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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