If there is to be rapid progress in limiting the increase of carbon dioxide (CO2) in the atmosphere, it will depend substantially on federal tax credits and state incentives for carbon capture and storage. For now, carbon capture and storage strategies are largely of three kinds: (1) biological removal (using photosynthesis to fix atmospheric CO2 in soils, grasses and trees), (2) direct air capture (DAC) (removing atmospheric CO2 and injecting it into geological formations), and (3) capture of CO2 before it is released. All three forms of capture may be the subject of a tax credit under Section 45Q of the U.S. Internal Revenue Code.
On July 1, 2021, the IRS released Revenue Ruling 2021-13 (Rev. Rul. 2021-13). That ruling (i) provided an example of the functionality-based definition of carbon capture equipment found in final Section 45Q Treasury Regulations; (ii) held that an investor must own at least one component (and is not necessarily required to own all components) of carbon capture equipment in the “single process train” of carbon capture equipment at a facility in order to claim a Section 45Q tax credit; (iii) clarified that when one or more components of a single process train are placed into service prior to the single process train being placed into a state of readiness and availability for the capture, processing and preparation of carbon oxide for transport for disposal, injection or utilization, the applicable placed-in-service date is that of the single process train and not the component; and (iv) ruled that a different placed-in-service date applies for tax depreciation purposes as compared to Section 45Q tax credit purposes.
Background on the Section 45Q Tax Credit
The focus of the ruling is on “equipment” because the tax credit generally is for the benefit of owners of carbon capture equipment. This equipment must be originally placed in service at a “qualified facility.” To be eligible for the Section 45Q tax credit, carbon capture equipment at a qualified facility must capture qualified carbon oxide, and the qualified carbon oxide must be (a) disposed of in secure geological storage; (b) used as a tertiary injectant in an enhanced oil or gas recovery project, such as enhanced oil recovery (EOR), and then disposed of in secure geological storage; or (c) “utilized” in another qualified manner.
Qualified facilities are industrial or DAC facilities for which construction begins before Jan. 1, 2026. Qualified facilities must capture a minimum volume of qualified carbon oxide per year; however, there is no maximum amount that may be captured and still qualify for the Section 45Q tax credit.
The Section 45Q tax credit is available for a 12-year period, beginning when carbon capture equipment is originally placed in service. The applicable dollar amount of the credit depends on how developers use the carbon oxide after capture. For carbon capture equipment originally placed in service on or after Feb. 9, 2018, the Section 45Q credit increases yearly from (i) $34.81 per metric ton in 2021 up to $50 per metric ton in 2026 (adjusted for inflation afterward) for disposal in secure geological storage, and (ii) $22.68 per metric ton in 2021 up to $35 per metric ton in 2026 (adjusted for inflation afterward) for EOR, enhanced gas recovery or other qualified utilization.
Will the Ruling Make It Easier to Monetize the Tax Credit?
By allowing the tax credit to be divided among owners of the significant pieces of equipment used in capturing and storing the carbon oxide, the ruling gives more flexibility to project developers and investors.
The “partnership flip” is expected to be the preferred transactional structure in the Section 45Q tax equity market as the cost of industrial-scale carbon capture equipment falls. Partnership flip structures allow developers to monetize the credit by allocating it to tax equity investors that have sufficient income to use the credits generated. Typically, a developer seeks out 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, allowing tax attributes and cash distributions to be allocated flexibly between the developer and investors. Initially, most of the 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 “flip” and most of the taxable income, losses and remaining Section 45Q tax credits are allocated to the developer.
For the purposes of the Section 45Q tax credit, the credit-generating asset is the carbon capture equipment. For equipment placed in service on or after Feb. 9, 2018, the developer is the entity that owns the equipment and physically or contractually ensures the sequestration of the captured carbon oxide. The “contractually ensures” language allows developers to contract or subcontract the disposal, injection or utilization of the carbon oxide and still claim the tax credit, provided certain conditions are met. Developers also may make an election under Section 45Q(f)(3)(B) to allow a contractor that disposes, injects or utilizes the qualified carbon oxide to claim the credit, in effect transferring the credit. The flexibility and transferability of the credit ensures that developers and investors will be able to design flexible partnership structures or other arrangements to optimally allocate the Section 45Q tax credits to parties that can utilize them.
Under Rev. Rul. 2021-13, additional assistance to claim the credit was provided to developers and others by the IRS providing guidance that at least one component (and not all components) in a single process train must be owned by a single developer and providing helpful guidance as to how to calculate the placed-in-service date for purposes of the Section 45Q tax credit when a single process train includes multiple components, each of which are placed in service at different times.
President Biden’s Proposal
Investment in Section 45Q tax partnerships may soon increase rapidly as the Biden administration aims to increase the Section 45Q tax incentive for carbon capture, utilization and sequestration. Specifically, President Biden’s American Jobs Plan includes proposals to extend the Section 45Q tax credit to make it “easier to use for hard-to-decarbonize industrial applications, direct air capture, and retrofits of existing power plants.”
Moreover, in its General Explanations for 2022, the U.S. Treasury Department revealed three major proposals for enhancing the Section 45Q tax credit. First, the proposals would extend the “commence construction” date for qualified facilities by five years, from Jan. 1, 2026, to Jan. 1, 2031. This change would give developers and investors more time to plan, pool the necessary resources and wait for carbon capture to become more cost-efficient. Second, the Biden administration would provide an additional $35 credit for each ton of qualified carbon oxide captured from “hard-to-abate industrial carbon oxide capture sectors,” such as cement production, steelmaking, hydrogen production and petroleum refining, and disposed of in secure geological storage. That would bring the total to $85 per ton for these projects in 2026 (adjusting, in part, for inflation afterward). Third, the Biden administration would provide another additional $70 credit to DAC projects per ton of qualified carbon oxide disposed of in secure geological storage. Thus, the total Section 45Q tax credit for DAC projects with geological storage would be $120 per ton in 2026 (adjusting, in part, for inflation afterward).
President Biden’s proposals to augment the Section 45Q tax credit will, if enacted, further subsidize the development and implementation of industrial-scale carbon capture systems, especially DAC. Combined with falling costs, there is likely to be a large surge in developer and investor interest in forming Section 45Q tax equity partnerships to capitalize on the emerging commercial viability of DAC technology.
BakerHostetler thanks Michael Palmer, a second-year student attending the Northwestern University Pritzker School of Law, for research and drafting support.
 Carbon oxides are a class of organic compounds that contain only carbon and oxygen. See Carbon Oxides and Carbonates, Lumen Learning, available at https://courses.lumenlearning.com/introchem/chapter/carbon-oxides-and-carbonates/#:~:text=Carbon%20oxides%2C%20or%20oxocarbons%2C%20are,known%20but%20are%20rarely%20encountered (last visited July 7, 2021). The definition of “qualified carbon oxides” for purposes of the Section 45Q credit includes carbon dioxide and, on or after Feb. 9, 2018, was expanded to include other carbon oxides. In general, qualified carbon oxides include carbon dioxide and other carbon oxides that (i) are captured from an industrial source by equipment originally placed in service by an applicable in-service date; (ii) would otherwise be released into the atmosphere as greenhouse gas emissions or lead to such release; and (iii) are measured at the source of capture and verified at the source of disposal, injection or utilization. Sections 45Q(c)(1)(A)-(B).
 Section 45Q(a). For other qualifying uses, see Section 45Q(f)(5)(A).
 Power plants must capture at least 500,000 metric tons of qualified carbon oxide per year, facilities that emit less than 500,000 metric tons of qualified carbon oxide per year must capture at least 25,000 metric tons per year, and all other facilities and DAC facilities must capture at least 100,000 metric tons per year of qualified carbon oxide. Sections 45Q(d)(2)(A)-(C).
 The Section 45Q credit is available for carbon capture equipment placed in service before Feb. 9, 2018, but only until 75 million tons of carbon oxide have been captured and sequestered. Section 45Q(g). For equipment placed in service on or after Feb. 9, 2018, the credit is limited only by how much the taxpayer can capture and sequester in the 12-year period beginning when the equipment is put into service. Sections 45Q(a)(3), (4). See also The Tax Credit for Carbon Sequestration (Section 45Q), Congressional Research Service, tbl.1 (June 8, 2021), available at https://fas.org/sgp/crs/misc/IF11455.pdf (last visited July 7, 2021).
 Section 45Q(b)(1).
 To encourage hesitant investors, the IRS laid out a partnership flip transaction safe harbor in Revenue Procedure 2020-12. In the procedure, the IRS explains how tax partnerships used in connection with Section 45Q transactions can properly allocate the credit in compliance with applicable partnership tax rules and under what conditions investors will be considered bona fide partners. The procedure also provides an example of a permissible Section 45Q partnership structure, which is substantially similar to the typical partnership flip structure described above, with a 99 percent and 1 percent split on tax allocations for the investors and developer pre-flip, respectively, and a 5 percent and 95 percent split post-flip. Given its flexibility and the IRS’s guidance, the partnership flip structure is expected to be the common monetization structure of the Section 45Q tax credit.
 Treas. Reg. § 1.45Q-1(h)(1)(ii).
 Treas. Reg. § 1.45Q-1(h)(1)(ii), (h)(2).
 General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, Department of the Treasury, PDF 60 of 114 (May 2021), available at https://home.treasury.gov/system/files/131/General-Explanations-FY2022.pdf (last visited July 2, 2021).
 Fact Sheet: The American Jobs Plan, White House (March 31, 2021), https://www.whitehouse.gov/briefing-room/statements-releases/2021/03/31/fact-sheet-the-american-jobs-plan/.
 General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, Department of the Treasury, PDFs 60-61 (May 2021), available at https://home.treasury.gov/system/files/131/General-Explanations-FY2022.pdf (last visited July 2, 2021).
 Carbon Engineering, a developer of DAC technology, estimates that DAC could capture atmospheric carbon dioxide at a cost of $100 per metric ton. See https://carbonengineering.com/our-technology/ (last visited July 2, 2021).