Is the IRS Ready to Wrangle the 45Q Tax Credit Hogs?

(This is the fourth blog in a series on the 45Q tax credit. Read the first, second, third and fifth posts.)

Prior blogs have discussed how tax credits can be used by the government to give preferential treatment to the wealthy and powerful, how the 45Q tax credit is driving the carbon pipeline goldrush, and who benefits from this goldrush. This blog post investigates how hard is it to claim a 45Q tax credit, and whether or not the IRS will be able to herd the tax credit piggie pack so they don’t cheat.

When considering the paperwork requirements to claim a 45Q tax credit, think about it relative to the financial reward. A modestly sized ethanol plant might produce about 100,000 metric tons of CO₂ per year, which if entirely sequestered would produce an annual tax credit of up to $5 million per year. When the carbon emissions from multiple emitters are captured by mega-carbon projects such as the Summit, Navigator, and ADM/Wolf CCS projects, the amount of tax credit capture planned is in the billions of dollars each. Combined, the tax credits from these three projects alone will likely be in excess of $20 billion. Given the lucrative nature of the 45Q tax credit and the fact that Congress has not limited how many projects can claim this credit, more CCS are being planned. If Congress keeps juicing, the 45Q tax credit program, it could balloon into a federal handout of hundreds of billions of dollars.

Given how much money is on the line, one would expect the IRS to set up an online reporting system and software to track and verify:

• the tons of CO₂ captured, shipped, sequestered, and used in EOR and other facilities; and
• tax credit claims and transfers among the owners of capture, sequestration, enhanced oil recovery, and carbon use facilities.

If the 45Q tax claims were to be stored in a database, it could be used to track and verify the credits as they bounce around the various corporations, partnerships, and joint ventures that will be making the claims. Is the IRS ready? Let’s go on an IRS paperwork safari and find out!

WARNING!

Before we venture into the IRS jungle, a warning: The IRS tax rules are a snarl of words slithering in bureaucratic knot of cross references. If the following discussion makes your brain lock up, feel free to jump to the end, and I will do my best to summarize the situation.

IRS Rules Related to Information Disclosure

First, for the truly masochistic, here are the key IRS 45Q rules related to information disclosure:

• 26 CFR § 1.45Q-1(h)(3)(iv)-(vi) contains the general annual information disclosure requirements for the 45Q tax credit;
• 26 CFR § 1.45Q-1(h)(2)(v) contains annual reporting requirements for contracts to capture, dispose, inject, or utilize carbon oxides;
• 26 CFR § 1.45Q-2(j) requires all tax credit claimants to annually file IRS Form 8933.
• 26 CFR § 45Q-1(h)(2)(v) requires that all contractors that capture, dispose, inject, or utilize carbon oxides to complete Form 8933 and provide it to the tax credit claimant who then attaches it to the claimant’s Form 8933.

Rather than walk through these rules in detail, suffice to say the IRS requires all entities that own capture equipment, all entities that sequester or use CO₂, and all entities that work under contract for them, to fill out IRS Form 8933 and provide additional information specified in the rules. This additional information will be discussed below in the context of some model certificates provided by the IRS.

IRS Form 8933: As Little as One Check Box and Three Numbers

The IRS requires that entities claiming the 45Q tax credit to complete and file Form 8933 with their tax return.   This form is two pages long and contains six check boxes and 16 boxes for numbers, but not all of them need be check or filled in. Even though tax forms make most people’s skin crawl, I suggest you look over Form 8933. It is much simpler than a standard tax return. The Form contains four parts.

Part I contains four check boxes that require the entity filing the form to state whether it:

• is a capture facility owner;
• is a disposal facility owner;
• a capture facility owner that has assigned tax credits to a disposal facility owner; and/or
• a disposal facility owner that has received tax credits from a capture facility owner.

Since a single claimant could own both capture and disposal facilities, It is entirely possible that a claimant could check all four boxes.

Parts II and III of Form 8933 are very similar. Part II is for facilities placed in service before February 9, 2018, and Part III is for facilities placed in service after this date. Otherwise, the required information is the same. Each part requires disclosure of the total tons of carbon captured at all facilities owned by the claimant broken out by whether this carbon is (a) sequestered, (b) used for EOR, or (c) used in other commercial processes. Then each of these totals is multiplied by the applicable per ton tax credit (e.g., $50/ton for sequestered carbon), to produce a dollar figure for the total tax credit claimed. For example, an entity claiming a tax credit in 2027 for carbon sent to EOR facilities would state how many tons were sent to these facilities, multiply this number by $35 per ton, and then write the total dollar amount of the claimed tax credit. A tax credit claimant could have an ownership interest in one or more capture and disposal facilities placed in service before and after the 2018 deadline.

Part IV is for other information. It contains two check boxes and four boxes for numbers. The two check boxes relate to the right of claimants to treat capture facilities that were in service before February 9, 2018, the same as facilities brought online after this date (the right of old facilities be get the same deal as new facilities). The boxes for numbers require disclosure of:

• Line 9: the total dollar amount tax credits transferred to the disposal entity filling out the form by one or more capture facilities owners;
• Line 10: the total dollar amount of tax credits assigned to the claimant by “Partnerships and S corporations”;
• Line 11: the total dollar amount of tax credit claimed calculated by adding the tax credits calculated in Parts II and III to transferred tax credits (Line 9) and tax credits distributed to the claimant by partnerships and S corporations (Line 10); and
• Line 12: the total amount of carbon that was previously claimed for credit in other years, but that was discovered to have leaked or otherwise been removed from the ground and therefore deducted from current credit claims.

In the simplest situation where a 45Q tax credit claimant owns and reports on a single carbon capture facility that came online after 2018 and sequesters carbon at a location owned by the claimant (as is the case at the ADM sequestration site in Decatur, Illinois), the claimant would (a) check the boxes on Lines 1 and 2; (b) provide the total tons captured in Line 4a, (c) multiply this by the per ton credit amount in Line 4b and write the result in Line 4c; and (d) write this same amount again on Line 11. So, as a first step to claiming millions of dollars in tax credits per year, the entity claiming the tax credit would need to check two boxes and write three numbers.

Form 8933 doesn’t even include a line for the name of and other basic information about the claiming entity, because Form 8933 is made to be attached to a claimant’s tax return. Since it is part of a tax return, the data provided on Form 8933 is treated by the IRS as private confidential information and cannot be released to the public. IRS Final Rule, 86 CFR 4742 (Jan. 15, 2021). Thus, the identities of the entities claiming the 45Q tax credit will not be disclosed to the public, nor will the amount of the tax benefits received by them, such that citizens will not have any opportunity to monitor use of the 45Q tax credit and press for enforcement. Instead, the IRS will publish the annual total metric tons of credits claimed by all 45Q tax credit claimants combined. Id.

The important point here is that Form 8933 is for bottom line numbers, meaning total tons of carbon captured at multiple facilities owned by a claimant; total tax credits transferred to a disposal claimant by one or more capture facilities; and total tax credits distributed from one or more partnerships and S corporations. When one considers the tax credit ownership options allowed by the IRS, the right of capture facilities to transfer credits to disposal facilities, and the potential for many different entities and individuals to claim tax credits [link to 45Q Blog #3], each Form 8933 could report bottom line numbers combining tax credits generated by multiple capture and disposal facilities that are then passed through various partnership, S corporations, and joint ventures to the final claimant. By itself, Form 8933 contains no details that would allow the IRS to track 45Q tax credit claims and prevent fraud.

Deeper into the IRS Jungle

Does the IRS require any more reporting? Yes. IRS Rule 26 CFR § 1.45Q-3 describes the requirements for proving that carbon has been sequestered or used. Subsection (c) states “[d]ocumentation must be filed in accordance with Form 8933.” Subsection (d) states that EOR (not geologic sequestration) claimants that report volumes injected underground to the EPA under 40 CFR Part 98 Subpart RR may self-certify, and that EOR claimants that rely on the sequestration standard found in CSA/ANSI ISO 27916:2019 must have an independent qualified independent engineer or geologist certify that the documentation provided is accurate and complete.

So, what does that mean? First, the IRS regulations do not require that tax credit claimants provide any detailed reporting of physical carbon capture, sequestration, or use data to the IRS, and instead appears to generally rely on the tons of carbon reported to the USEPA by capture and use facility operators. This means that the IRS does not itself perform any physical verification of the carbon captured, sequestered or used. The IRS does not appear to require sequestration sites to provide any certification whatsoever, and it allows EOR sites to simply self-certify, meaning that a company official would sign a statement asserting that the numbers on Form 8933 are true. As an option, an EOR company could report under a different international carbon reporting standard called CSA/ANSI ISO 27916:2019, and then attach a similar statement by an “independent” engineer or geologist, asserting that the carbon figures are correct. It seems doubtful that many EOR companies would use this option.

Thus, tax credits claimed can be self-certified if the claimant reports to the USEPA, or otherwise must be certified by an independent petroleum engineer or geologist. Either way, the IRS rules do not require independent verification of any reported carbon amounts.

Essentially, the IRS relies on reporting to the USEPA as the basis for believing that the figures provided on Form 8933 are correct. The EOR-related certifications must be made annually and under penalty of perjury, and a failure to submit these certifications results in forfeiture of the 45Q tax credit. 26 CFR § 1.45Q-3(e).

So, what does the USEPA require? We’ll get to that in another blog post, as there is some additional IRS paperwork to consider.

Line 9 of Form 8933 requires that claimants attach one or more of eight “Model Certificates,” which are described and provided in the IRS’s instructions for Form 8933. These one-to-five-page forms are the IRS’s recommended formats for how 45Q tax credit claimants provide the information required by 26 CFR § 1.45Q-1(h)(2)(v) and 26 CFR § 1.45Q-1(h)(2)(iv) and (v). They provide reporting formats for the various types of entities that are required to report data to the IRS.

If I walked you through each of these forms in detail 98.3% of your brains would explode, and only tax accountants, lawyers and IRS employees would survive, albeit with brain damage. If you want to risk it, the Model Certificates can be found at the end of the instructions for Form 8933.

There are a few interesting things about these forms.

The fact that these certificates are called “models” indicates that tax credit claimants are not required to use them or to report data in any standardized format. Page 1 of the Form 8933 instructions state: “filers should use attachments substantially similar to the model certificates . . . .” Therefore, the IRS does not require use of the models. Further, many of the model certificates state that if additional space is needed the entity completing the certificate should provide supplementary materials. The IRS does not provide a format for these supplementary materials.

Moreover, the Paperwork Reduction Act states that entities are not required to provide the information requested on a form that is subject to the Paperwork Reduction Act unless the form displays a valid OMB control number. Although Form 8933 has an OMB number, neither its instructions nor the Model Certificates have OMB numbers. Therefore, 45Q tax credit claimants must comply with the information requirements contained in in 26 CFR § 1.45Q-1(3)(iv)-(vi), but they are not required to use the Model Certificates.

The Model Certificates require identification of (a) all of the capture facility owners and operators, (b) all disposal facility owners and operators, and (c) the tons of CO₂ captured and/or disposed by each facility. In addition, capture facility owners must identify the amounts of tax credits transferred from them to disposal facility owners. The Model Certificates also require that the tons of CO₂ captured and disposed be “consistent” with “with figures reported to the EPA pursuant to the applicable MRV plan and subpart RR of EPA’s Greenhouse Gas Reporting Program” or in compliance with the ISO 27916 carbon sequestration standard as certified by an independent engineer or geologist.

In theory, assuming the IRS compiles the data from the Model Certificates, the data contained in the Model Certificates could be used to track and audit use of the 45Q program. For a number of reasons, it is likely that such undertaking would be extremely difficult and unlikely to provide clear evidence of intentional malfeasance by 45Q tax credit claimants. In particular, the CCS capture, pipeline, sequestration, EOR, and utilization projects being developed involve many carbon capture facilities, with potentially multiple owners at each facility, that could transfer carbon to one or more sequestration and EOR permittees or other users, each of which could also have multiple owners. Moreover, the information needed to track capture, sequestration, and use of carbon would also be provided by various contractors and subcontractors to the multiple tax credit claimants.

The failure of the IRS to require uniform reporting via an online database means that all of the tracking data contained in the Model Certificates would be provided either as hard copies or pdfs, meaning that any tracking or enforcement action would require laborious and time-consuming conversion of this complex information into a tracking database. Therefore, it appears that the IRS is not planning to monitor or track carbon capture and use or transfers of tax credits between capture and disposal facilities and from partnerships, S corporation, and joint ventures to their various owners. Absent a far more sophisticated reporting and tracking system, it seems likely that the IRS is not planning to verify billions of dollars in tax credit claims. As a consequence, there is a substantial risk of widespread 45Q fraud and a lack of effective enforcement.

It appears that the IRS will simply assume that the capture, EOR, and use industries will report truthfully. Given that the IRS employs far fewer revenue examiners and audits a smaller proportion of millionaires than in the past, it is likely that the IRS will investigate potential 45Q tax fraud only when an investigation is triggered by whistleblowers, obvious violations, as a result of an IRS audit of a particular entity, or if requested by Congress.

Moreover, the US oil industry is planning for a dramatic increase in CO₂-EOR projects that acquire carbon from a large-scale carbon market that would accept CO₂ from many sources and allow sales to many potential customers, including also sequestration and non-EOR use customers, all managed by contractors whose 8933’s would also be provided to the IRS. Given this intention to massively scale up use of the 45Q tax credit, it seems likely that the IRS will be inundated with tax filings and Model Certificates from thousands of 45Q tax credit claimants, whose claims will be based on ownership interests in multiple capture, sequestration, EOR, and utilization projects owned via complex corporate, partnership, and joint venture structures.

Depending on how it is organized, the Summit project alone could result in annual filings of multiple dozens of Form 8933s and many hundreds of pages of non-uniform information contained in the Model Certificates or approximations thereof. The Summit project currently intends to ship CO₂ from 31 separate proposed carbon capture facilities to North Dakota, where such CO₂ could be geologically stored in the Project Tundra sequestration site, or Summit’s planned sequestration site, or possibly be used in multiple future EOR projects. Each capture facility could transfer some or all of its tax credits to one or more of these geologic sequestration or EOR site owners. All of these entities could be owned by interrelated corporations, partnerships, and/or joint ventures. Tracking the transfers of tax credits for just the Summit project would be challenging. Attempting to track the tax credits generated by a nationwide carbon market would likely be impossible.

This system is so complex that an entity accused of fraud could likely claim an honest error or confusion with regard to credit ownership and transfers. It might be difficult to impossible to prove intentional 45Q tax fraud. There would seem to be little risk of being caught cheating, and even then most cheaters could hire an army of tax lawyers to defend it.

Summary

The 45Q tax credit claimants are required to report data to the IRS on credits generated and transferred that could in theory be used to catch tax fraud, but given that this data will be collected in non-standardized hard copy and/or pdf forms, it seems far more likely that this data will simply gather dust in an IRS file until either it becomes too old to use or the fraud becomes so obvious that Congress requires an investigation, and then it will be too late.

The tax credit piggies will likely be free to roll around in federal tax credit hog heaven with limited to no risk of meaningful federal control.

The next blog will examine the USEPA’s tracking of carbon capture, sequestration, and use, to see if it will have the capacity to wrangle the 45Q tax credit piggies.