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June 22, 2020

IRS Issues Proposed Regulations On Section 45Q Carbon Oxide Sequestration Credits


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The U.S. Internal Revenue Service (IRS) and the U.S. Treasury Department (“Treasury”) have issued proposed regulations (REG-112339-19) providing valuable guidance on credits for the sequestration of qualified carbon oxide (CO) under Section 45Q of the Internal Revenue Code (the “Proposed Regulations”). Congress enacted Section 45Q in October 2008, but the credit program failed to attract widespread attention. Congress revised Section 45Q in 2018 intending to stimulate investor appetite, but developers remained cautious due to a lack of guidance and resulting uncertainty. The Proposed Regulations provide helpful guidance that should eliminate several key roadblocks faced by developers, but some questions still remain.

The Proposed Regulations will apply to taxable years beginning on or after the date the final regulations are published in the Federal Register. Until the applicability date of the final regulations, taxpayers may rely either on guidance provided in the Proposed Regulations for taxable years beginning on or after February 9, 2018, provided the Proposed Regulations are followed in their entirety and in a consistent manner.

The Proposed Regulations provide clarity in four key areas:

  • basic eligibility requirements for claiming the credit and use of defined terms;
  • a limited framework for recapturing previously claimed credits when CO escapes back into the atmosphere;
  • standards for ensuring secure geological storage; and
  • requirements for contractually assuring the capture and disposal of CO.

Background on Section 45Q Credits

Congress enacted Section 45Q in 2008 to incentivize greenhouse gas sequestration, with a specific focus on projects that used carbon dioxide as a tertiary injectant to stimulate oil and gas production from marginal wells in a process commonly referred to as “enhanced oil recovery,” or “EOR.” Congress later amended Section 45Q as part of the Bipartisan Budget Act of 2018 (BBA Amendment, February 9, 2018) to extend availability of the credit to cover a broader range of commercial applications.

As originally enacted, Section 45Q provided a credit of $20/metric ton of qualified carbon dioxide captured at a qualified facility and disposed of in secure geologic storage, and a credit of $10/metric ton for carbon dioxide captured at a qualified facility and used in an EOR process before being disposed of in secure geologic storage. Notably, Section 45Q applied only to carbon dioxide, and not to other forms of CO such as carbon monoxide, and was scheduled to expire when Treasury, in consultation with the Environmental Protection Agency (EPA), certified that 75 million metric tons of qualified carbon dioxide had been recaptured via the utilization of Section 45Q. Since taxpayers needed at least 500,000 metric tons of qualified carbon dioxide to qualify for credits in any single year, the cap of 75 million metric tons meant that a few dozen qualifying participants likely would exhaust the credit program in five or six years. Moreover, credits under Section 45Q initially were made available only to a taxpayer who (1) captured carbon dioxide that otherwise would have been released into the atmosphere and (2) ensured that carbon dioxide was secured in geological storage (whether or not first used in an EOR process). In addition, Section 45Q applied only to carbon dioxide captured at a “qualified facility,” which originally was defined as any industrial facility owned by a taxpayer and at which carbon capture equipment was placed in service that captured not less than 500,000 metric tons of carbon dioxide during the taxable year. Perhaps unsurprisingly, Section 45Q failed to attract much attention for at least a decade. The renewables market continued to focus primarily on wind and solar, where fewer technical requirements and the availability of low-cost financing presented lower barriers to entry.

Congress amended Section 45Q as part of the Bipartisan Budget Act of 2018 (BBA Amendment, February 9, 2018) to incorporate a number of investor-focused incentives. As amended, Section 45Q now applies to the sequestration of “qualified carbon oxide,” as opposed to “qualified carbon dioxide,” which picks up a wider range of greenhouse gases. Furthermore, Section 45Q no longer expires upon reaching a total program cap of 75 million metric tons of carbon dioxide, and instead provides for increased credit amounts that can be claimed over a 12-year period. For CO captured using carbon capture equipment originally placed in service on or after the enactment of the BBA (February 9, 2018), and disposed of but not used for EOR, the credit amounts range from $22.66/metric ton in 2017 to $50/metric ton starting in 2026 (subject to further adjustments for inflation). For CO captured using carbon capture equipment originally placed in service on or after February 9, 2018, and used in EOR, the increased credit amounts range from $12.83/metric ton in 2017 to $35/metric ton starting in 2026 (subject to further adjustments for inflation).

Another change under the BBA Amendment affects who can claim the credit. Under the old law, the credit was claimed by the person capturing the CO, but typically that person (often a developer) lacked sufficient taxable income to fully utilize the credit. Section 45Q now provides that the person who owns the CO capture equipment will be eligible to claim the credit, and that person also may elect to transfer the credit to another person who disposes or uses the CO. However, the BBA Amendment stopped short of describing how a person should contractually ensure that a third party captures, disposes of, or utilizes the CO as a proxy for demonstrating compliance with the various requirements under the statute.

The BBA Amendment also expands the scope of qualified facilities that may give rise to Section 45Q credits. Specifically, Section 45Q now expands beyond industrial facilities to include direct air capture facilities that remove CO from the ambient atmosphere. Construction of the qualified facility must begin before January 1, 2024, which requires either construction of carbon capture equipment to begin before such date or that the original planning and design for such facility include installation of carbon capture equipment. Likewise, the BBA Amendment expands the application of Section 45Q to a broader audience by reducing the minimum annual CO sequestration threshold. In this regard, the BBA Amendment reduces the threshold from 500,000 metric tons/year to 100,000 metric tons/year, which is expected to extend eligibility to a broader range of industrial facilities, including concrete plants, ethanol plants and other facilities having a similar emissions profile (but not electricity generation facilities, where the higher annual threshold of 500,000 metric tons will continue to apply).

Notwithstanding the BBA Amendment, Section 45Q continues to provide few specifics regarding secure geological storage or the recapture of credits if carbon dioxide escapes back into the atmosphere. Instead, Congress deferred to Treasury, the EPA, the Secretary of Energy, and the Secretary of the Interior to establish regulations for determining the adequacy of “secure geological storage” facilities, which Section 45Q indicated should include “storage at deep saline formations, oil and gas reservoirs, and unminable coal seams,” as Treasury may determine under such forthcoming regulations. Likewise, Section 45Q deferred to Treasury to provide regulations addressing the recapture of credits, without specifying any time limits.

Notice 2019-32, Notice 2020-12 and Revenue Procedure 2020-12

On May 2, 2019, the IRS issued Notice 2019-32 announcing its intention to issue regulations under Section 45Q and requesting comments on several key issues, including procedures to ensure secure geological storage and the measurement of CO, the recapture of the benefit of the credit for CO sequestration, and contractual agreements with third parties who capture, dispose of or utilize CO. Notice 2019-32 also requested comments on whether guidance was needed concerning structures in which project developers and participating investors would be respected as partners in a partnership generating a Section 45Q credit, and whether such guidance should specifically address allocations of the credit or recapture of the credit among the partners in the partnership.

In February, the IRS issued Notice 2020-12, which provides guidance pertaining to the beginning of construction requirement, and Revenue Procedure 2020-12, which provides a safe harbor for partnerships to make valid allocations of the CO sequestration credit under Section 45Q. For purposes of the beginning of construction requirement, the Notice adopts guidance commonly applied to other renewables projects such as wind and solar and indicates that carbon capture projects will be considered to have begun construction for purposes of qualifying for the Section 45Q credit if the taxpayer starts “physical work of a significant nature” or pays or incurs at least five percent of the total cost of the project. For purposes of the partnership safe harbor, the Revenue Procedure generally adopts prior guidance issued in the context of the Section 45 wind energy production tax credit and the Section 47 rehabilitation tax credit “partnership flip” structures under Revenue Procedures 2007-65 and 2014-12, respectively. In the Section 45Q context, the Revenue Procedure contemplates a project developer (“Developer”) entering into a partnership (the “Project Company”) with a tax credit investor (“Investor”) to own and operate CO capture equipment (“Equipment”). Under the safe harbor, the Project Company may acquire CO from a CO emitter (“Emitter”) or sell CO to a CO purchaser (“Offtaker”). The safe harbor under Revenue Procedure 2020-12 is generally consistent with such prior guidance, except in a few respects. For example, while Revenue Procedure 2007-65 permits a Developer, Investor, or any related parties to have a call option to purchase the equipment, the project, or another party’s interest in the partnership at its then fair market value (provided certain requirements are satisfied), Revenue Procedure 2020-12 does not permit such call options. On the other hand, Revenue Procedure 2020-12 permits the Investor to make up to 50 percent of its capital contributions contingent on the amount of carbon captured and the amount Section 45Q credits generated, in comparison to the 25 percent threshold permitted under Revenue Procedure 2007-65.

To qualify for the Revenue Procedure’s safe harbor, the following requirements must be met:

  • the Developer must maintain at least a one percent interest in each material item of partnership income, gain, loss, deduction and credit at all times during the life of the partnership;
  • each Investor must maintain, at all times during its holding period in the partnership, a minimum interest in each material item of partnership income, gain, loss, deduction and credit that is equal to at least five percent of the Investor’s highest percentage allocation of each such item at any time;
  • the Investor’s partnership interest must constitute a bona fide equity investment with no substantial protection from losses, no limitations on upside returns when compared with a reasonable preferred return on capital and no reductions to its value attributable to developer fees or other arrangements that are unreasonable compared with similarly situated projects in the marketplace that do not qualify for the Section 45Q credit;
  • at the time of investment, the Investor must make an unconditional minimum investment in the Project Company equal to 20 percent of the sum of the Investor’s fixed capital commitment to the Project Company plus any reasonably anticipated contingent investment required to be made by the Investor to the Project Company under the partnership agreement (with at least 50 percent of such sum being non-contingent), which 20 percent investment must be maintained throughout the duration of the Investor’s holding period with the exception of distributions of cash flow received by the Investor from the Project Company, and which investment cannot be protected from losses by the Developer, any other Investor, an Emitter, an Offtaker or any such party’s affiliate;
  • neither the Developer, the Investors nor any related person may have a call right to purchase the equipment or a partnership interest in the Project Company at a future date (other than a contractual right or agreement for a present sale), and the Investor’s partnership interest must be held free from any put rights;
  • no party involved in the Project Company may directly or indirectly guarantee or otherwise insure the Investor’s ability to claim the Section 45Q credit or equivalent thereof; provided that the Investor still may obtain tax insurance from an unrelated third party; and
  • allocations under the Project Company’s partnership agreement must satisfy the requirements of Section 704(b) of the Internal Revenue Code and the regulations thereunder.

The Section 45Q credit (and any recapture thereof) must be allocated in accordance with Treasury Regulations Section 1.704-1(b)(4)(ii) (i.e., if the Project Company generates receipts from its activities relating to CO capture, and those receipts give rise to valid allocations of partnership income, an allocation of the Section 45Q credit will be treated as in accordance with the partners’ interests in the partnership if the credit is allocated in the same proportion as the partners’ respective distributive shares of such income).

Revenue Procedure 2020-12 provides an example of a “partnership flip” structure that utilizes the safe harbor requirements described above. In the example, the Project Company captures CO from an Emitter and sells the CO to an Offtaker. Under a contract with the Project Company, the Offtaker agrees to purchase the CO for use as a tertiary injectant in an EOR project, to store the CO in secure geological storage, and avoid any release of the stored CO.

Guidance Under Proposed Regulations

The Proposed Regulations, released on May 28, 2020, clarify the basic eligibility requirements for claiming the Section 45Q credit and the use of certain defined terms. In addition, in response to concerns raised in comments to Notice 2019-32, the Proposed Regulations describe a method for measuring and calculating the amount of CO leakage that is subject to recapture, the method for calculating recapture, and the lookback period during which a recapture event may occur. Finally, the Proposed Regulations provide certain standards for ensuring secure geological storage and related monitoring, as well as a framework for demonstrating contractual assurance that CO will be properly captured and stored. Each of these topics is discussed in more detail below.

Eligibility Requirements and Use of Certain Defined Terms

The Proposed Regulations restate certain statutory definitions and clarify the use of certain other defined terms appearing in Section 45Q. For example, the Proposed Regulations define “industrial facility” to mean “any facility that produces a carbon oxide stream from a fuel combustion source or fuel cell, a manufacturing process, or a fugitive carbon oxide emission source that, absent capture and disposal, would otherwise be released into the atmosphere as industrial emission of greenhouse gas or lead to such release.” The Proposed Regulations specifically exclude from the definition of “industrial facility” any facility that “produces carbon dioxide from carbon dioxide production wells at natural carbon dioxide-bearing formations or a naturally occurring subsurface spring,” but specifies that “[a] deposit of natural gas that contains less than 10 percent carbon dioxide by volume is not a natural carbon dioxide-bearing formation.” Furthermore, the Proposed Regulations specify that whether a deposit of natural gas containing 10 percent or greater carbon dioxide by volume should be considered a natural carbon dioxide-bearing formation is to be “based on all the facts and circumstances.”

Some taxpayers that placed carbon capture equipment in service prior to February 9, 2018, may retrofit facilities on or after February 9, 2018, by making physical modifications to existing carbon capture equipment or installing additional carbon capture equipment. Under the “80/20 Rule,” the Proposed Regulations provide that carbon capture equipment placed in service on or after February 9, 2018, may qualify as originally placed in service on or after February 9, 2018, even if it contains some used components of property that were previously placed into service, provided the fair market value of the used components is not more than 20 percent of the carbon capture equipment’s total value. For purposes of the 80/20 Rule, the cost of new carbon capture equipment includes all properly capitalized costs of the new carbon capture equipment, plus the cost of new equipment for a pipeline owned and used exclusively by the taxpayer to transport CO captured from that taxpayer’s qualified facility.

In contrast, the Proposed Regulations provide that any facility placed in service prior to February 9, 2018, that is retrofitted on or after February 9, 2018, in a manner that does not satisfy the 80/20 Rule will be subject to bifurcation. In this regard, the Proposed Regulations provide that a taxpayer must bifurcate the calculation of CO captured using equipment placed in service prior to February 9, 2018, and claim credits with respect to such equipment under Section 45Q(a)(1)(A) or Section 45Q(a)(2)(A), subject to the 75,000,000 metric ton limitation. If the additional equipment installed on or after February 9, 2018, results in an increase in the CO capture capacity of the existing carbon capture equipment and the facility actually captures additional CO during the taxable year using such increased capacity, the taxpayer should claim additional credits with respect to the capture of additional CO using such increased capacity under Section 45Q(a)(3)(A) or Section 45Q(a)(4)(A).

The Proposed Regulations also provide guidance for situations where carbon capture equipment is placed in service prior to February 9, 2018, but for which no taxpayer claimed any Section 45Q credits for any taxable year ending before February 9, 2018. In this situation, the Proposed Regulations permit the taxpayer to make a Section 45Q(f)(6) election on an annual basis to treat the facility, and any carbon capture equipment placed in service at such facility, as having been placed in service on February 9, 2018, provided that the facility must capture not less than 500,000 metric tons of CO for the year for which the Section 45Q(f)(6) election is being made. The Proposed Regulations describe the time and manner for making the Section 45Q(f)(6) election.

Recapture Requirements

Section 45Q directs Treasury to provide regulations for recapturing the benefit of any Section 45Q credit attributable to CO leakage at a secure geological storage facility. How Treasury defines recapture has been a key concern for developers and industry advocates, with many submitting comments outlining various proposals to limit unreasonable downside risk for investors. In response to those comments, the IRS and Treasury have adopted an approach under the Proposed Regulations that should limit any potential recapture to a five-year lookback period. If a leak is discovered, the recapture amount will be accounted for in the taxable year in which the leakage is identified and reported. If the leaked amount does not exceed the CO captured and stored in the year in which the leakage is reported, there is no recapture amount and no further adjustments to prior taxable years will be required. If the leaked amount exceeds the CO captured and stored in the taxable year in which the leakage is reported, then the excess must be recaptured by multiplying the metric tons of excess CO by the appropriate statutory credit rate on a last-in-first-out basis, such that Section 45Q credits claimed in prior years are recaptured in reverse order up to a maximum of the fifth preceding year. Recapture adjustments attributable to the five-year lookback period are added to the amount of tax due in the taxable year in which the recapture event occurs.

Secure Geological Storage

The Proposed Regulations provide certain standards under Section 45Q for secure geological storage, whether for purposes of disposal through sequestration, or in connection with the use of CO for EOR. To meet the requirements for disposal through sequestration, a taxpayer must dispose of and store the CO in compliance with applicable requirements under 40 CFR Part 98 subpart RR (“Subpart RR”). Subpart RR requires that the disposal site owner obtain EPA or qualifying state approval for a monitoring, reporting and verification plan (MRV), but taxpayers who obtain approval for an MRV may self-certify the amount of CO being stored. In the case of CO being used for EOR purposes, the taxpayer must either comply with Subpart RR or, alternatively, report under the International Organization for Standardization (ISO) standard for quantifying safe long-term storage of CO in association with enhanced oil recovery provided in CSA/ANSI ISO 27916:19 (the “ISO Process”). Taxpayers using the ISO Process for EOR must obtain independent third-party verification annually from a qualified engineer or geologist certifying the amount of CO being stored.

Contractually Ensuring Capture and Disposal, Injection or Utilization of CO

The Proposed Regulations clarify that a taxpayer is not required to physically carry out the disposal, injection or utilization of CO to claim Section 45Q credits if the taxpayer contractually ensures in a binding written contract that the party that physically carries out the disposal, injection or utilization of the CO does so in a manner required under Section 45Q and final regulations. A taxpayer may enter into one or more such contracts with multiple parties. For this purpose, contracts ensuring the disposal, injection or utilization of CO must (1) include commercially reasonable terms providing for enforcement of the obligation to perform (without limiting damages to a specified amount); (2) in the case of permanent sequestration unrelated to EOR, obligate the disposing party to comply with secure geological storage requirements, including Subpart RR, and to promptly report all necessary details pertaining to recapture events such as leaks; (3) in the case of EOR, obligate the disposing party to comply with secure geological storage requirements, including Subpart RR or the ISO Process, and to promptly report all necessary details pertaining to recapture events; and (4) in the case of the utilization of CO in commercial applications under Section 45Q(f)(5), obligate the utilizing party to comply with Prop. Treas. Reg. § 1.45Q-4. The Proposed Regulations specify that the existence of each contract and the parties involved must be reported to the IRS annually on IRS Form 8933, Carbon Oxide Sequestration Credit (or applicable successor form), by each party to the contract, regardless of the party claiming the credit.

The IRS published the Proposed Regulations in the Federal Register on June 2, 2020. Written or electronic comments on the Proposed Regulations are due by August 3, 2020.

Authors and Contributors

Larry Crouch



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+1 212 848 4431

+1 650 838 3718

+1 650 838 3718

New York

Todd Lowther



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+1 713 354 4898


Ryan Bray



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+1 214 271 5680

+1 650 838 3726

+1 650 838 3726




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