The US Department of the Treasury’s Proposed Guidance for the Tech-Neutral Tax Credits

On Wednesday, May 29, the Department of Treasury and the Internal Revenue Service released proposed guidance for the section 45Y production tax credit (PTC) and the section 48E investment tax credit (ITC). These tax credits serve as a technology-neutral replacement for the existing tax credits for clean electricity. As we detailed in our prior issue brief, these new tax credits provide a welcome consistency and certainty to the tax code but also present a few novel questions to be resolved. Treasury has given the public 60 days to comment on the proposed guidance, ending on August 2. In this issue brief, we discuss what is new in the guidance, how Treasury has resolved some of the issues we previously identified and what major questions remain to be addressed through the public comment process.

1.1. Qualifying Technologies

Perhaps the most important aspect of this guidance is that Treasury published an initial list of technologies that can qualify for these tax credits:

• wind
• solar (photovoltaic and concentrating)
• marine
• hydro
• geothermal
• nuclear fission and fusion
• waste heat recovery from any of the technologies above

Notably, these are all technologies that are not classified as combustion and gasification (C&G) technologies. While C&G technologies require a full life-cycle analysis (LCA) to determine their emissions rate, non-C&G technologies consider only the direct emissions from electricity production. Treasury states that it intends to release the formal list of technologies and associated emissions rates after the final guidance is released. Treasury requires an analysis prepared by at least one National Laboratory to add, remove or change a technology on the list and requests comment on this process. A developer may rely on the list as of the date a facility begins construction to determine its eligibility for the tax credit. In addition, Treasury states that developers can rely on the initial list above until the formal list is published.

With respect to storage technologies, which can only qualify for the section 48E ITC, no published list is required. The definition of an energy storage technology in the statute refers to the definition in the original section 45 investment tax credit (26 U.S.C. 48(c)(6)). Treasury specifically lists the following storage technologies that can qualify for this tax credit in the proposed guidance:

• electric storage
• thermal storage
• hydrogen storage

1.2. Combustion and Gasification Technologies

Treasury does not list any C&G technologies as qualifying for the credits in the proposed guidance but does clarify when technologies should be considered C&G. According to the guidance, a technology qualifies as C&G if any combustion or gasification occurs either at the point of generation or upstream in the production of the technology’s feedstock or fuel. For example, although no combustion occurs in a hydrogen fuel cell, if the fuel cell uses hydrogen that was produced from the grid, it would qualify as a C&G technology under this definition because the hydrogen was produced from electricity which, being from the grid, was produced in part via combustion. However, a fuel cell using geologic hydrogen would not count as a C&G technology. Treasury requests comment on this definition and what sort of analysis would be necessary to demonstrate whether combustion or gasification occurred in the supply chain for a technology.

1.3. Life-Cycle Analysis

For these tax credits, a full life-cycle analysis (LCA) is required to determine the emissions rates of C&G technologies. These tax credits refer to the definition of life-cycle analysis in the Clean Air Act (42 U.S.C. 7545(o)(1)(H)), as modified by the Energy Independence and Security Act of 2007. The proposed regulation from Treasury follows the language of the act, referring to the inclusion of direct and “significant indirect” emissions. Although the expression never appears in the proposed regulation itself, the text of the guidance makes it clear that Treasury proposes that the LCA should be what is called a consequential LCA. This means that the LCA should measure the difference in emissions compared with a counterfactual scenario. In the guidance, Treasury states, “the LCA must be based on a future anticipated baseline, which projects future status quo in the absence of the availability of the sections 45Y and 48E credits.”

Consequential LCA differs from attributional LCA, which involves the attribution of upstream emissions from the production of fuels to the end product rather than the computation of emissions compared with a counterfactual. An important difference is that consequential LCA includes “indirect” emissions, such as what might result from land use change due to biofuel production, while attributional LCA looks only at the direct supply chain of the fuel. The distinction between these two types of LCA is not always clear, and the analyses by the US Environmental Protection Agency (EPA) for the renewable fuels standard (and the GREET model by Argonne National Laboratory) can be thought of as a hybrid of the two. Interestingly, the guidance for determining life-cycle emissions for the section 45V hydrogen production tax credit uses an attributional LCA informed by consequential consideration.

As we discuss in Sections 2 and 3, Treasury requests comment on a broad set of issues relating to performing consequential life-cycle analysis. One point of clarity provided by the guidance is the boundary for the LCA, with the generation or extraction of initial feedstocks or fuels as the starting boundary and the “meter at the point of production” as the ending boundary. Anything downstream of electricity production, such as the emissions associated with the electricity displaced by the produced electricity, is not included.

Finally, Treasury allows the consideration of “alternative fates and avoided emissions.” An example of this is renewable natural gas (RNG), which is derived from methane that would have otherwise been released into the atmosphere. In this case, the avoided emissions are subtracted when calculating LCA emissions. Treasury does not allow the use of what the guidance refers to as “unrelated” offsets, however.

1.4. Other Considerations

For reconstructed facilities, Treasury adopts the existing 80/20 guidance that a facility is considered new as long as only 20 percent of the value of the new facility is from existing infrastructure. For expansions of existing facilities, the tax credits apply to the fraction of electricity output associated with the additional capacity, in the case of the PTC, or the cost of the incremental capacity, in the case of the ITC.

For facilities that do not have an entry on the published list, Treasury details a procedure to obtain a “provisional emissions rate.” Treasury will publish a list of allowable LCA models that a C&G facility can use to calculate an emissions rate, or, if the models are not applicable, the facility can petition the Department of Energy to provide a rate. As with the list of emissions rates, adding or removing an LCA model from the list of accepted models will require an analysis by a National Laboratory.

One important difference between the two tax credits is that while the 45Y PTC refers to the “greenhouse gas emissions rate,” the 48E ITC refers to a facility’s “anticipated greenhouse gas emissions rate.” This is presumably intended to award the ITC only to facilities that are expected to maintain a zero or negative emissions rate beyond the initial year. Treasury provides guidance that the anticipated emissions rate be based on “objective indicia” that the facility will maintain a zero or negative emissions rate for at least 10 years. This could include, according to the guidance, colocation with a fuel source or long-term contracts. Treasury requests comment on this issue broadly.

Finally, Treasury states that the threshold for phasing out the tax credits – that electric sector emissions are less than 25 percent of 2022 levels—should be based on achieving that level in both the US Energy Information Administration’s Electric Power Annual and EPA’s Greenhouse Gas Inventory. Treasury requests comment on alternative data sources.

In our previous issue brief, we identified several issues that Treasury should consider for its proposed guidance. In this section, we describe how Treasury addressed these concerns.

2.1. The Definition of a Facility

The first concern we identified was what constitutes a facility and the “expansion of facility.” Although it does not appear to be explicitly stated, a facility seems to be defined as the technology of the facility itself, its fuel inputs and the supply chain for those fuels, including any associated indirect effects. The supply chain and indirect effects are included to determine both whether the facility qualifies as C&G and, if it does, the consequential LCA emissions rate for those fuels. It is not clear if a facility is allowed to change its mix of fuels during its operations, even while maintaining a zero or negative emissions rate. With respect to expansions, Treasury followed the existing 80/20 guidance, as noted in Section 1.4.

2.2. Geothermal

The second concern we identified was whether geothermal energy will qualify for the tax credit. This has an easy answer: it does, in all its forms. Treasury achieves this via the second option we presented: reading the definition of emissions in the statute as not including the emissions released during geothermal generation. Certain emissions from hydropower and transformers were also excluded.

2.3. Biomass

For determining the emissions rate of biomass, our third concern, Treasury chose to follow a consequential LCA analysis. This raises the question of whether generation from biomass will be able to qualify for the tax credit. The experience with the renewable fuels standard suggests that most, if not all, life-cycle analyses will assign a positive emissions rate to biomass-derived fuels. Except when there are avoided emissions that have a higher global warming potential (GWP) than the combustion emissions (such as in RNG), it is hard to see how to achieve a zero or negative emissions rate. It is possible that no C&G technologies without the use of carbon capture and storage (CCS) will qualify unless a significant (negative) high-GWP offset can be demonstrated.

2.4. Book and Claim Systems

With respect to our question of whether generators can make use of book and claim systems to demonstrate the consumption (attributes) of clean fuels, Treasury requests comment but does not take a position in this guidance.

2.5. Negative Emissions

Regarding the issue of negative emissions, Treasury explicitly allows the consideration of avoided emissions or alternative fates in an LCA. This should allow fuels such as RNG and captured fugitive methane emissions to qualify. However, Treasury indicated that it has multiple concerns with such fuels and seems likely to put guardrails around their use. This is one of the major areas where Treasury requests comment.

2.6. Perverse Incentives from Credit Stacking

In our issue brief, we also identified a potential perverse outcome if a fuel cell were to receive a tax credit for producing electricity with hydrogen that had originally been produced using electricity from the grid. This would be a circular process that would waste energy and could result in increased emissions, while the fuel cell could still potentially receive the tax credit. By extending the definition of C&G to include upstream fuels, a fuel cell that runs on grid electricity would qualify as a C&G technology and have to undergo a full life-cycle analysis of its production, making it unlikely that it would receive the tax credit, potentially mitigating this problem.

In addition to the requests for comment mentioned in the earlier sections, Treasury primarily requests comment in three major areas: LCA; RNG, biogas, and fugitive methane; and carbon capture.

3.1. Life-Cycle Analysis

Within the area of LCA, Treasury requests comment on, among other things, LCA modeling; the parameters for the LCA, including spatial and temporal scales; how to deal with co- and other products; how to generate baselines for LCA and how to incorporate the heat production in combined heat and power generation.

3.2. RNG, Biogas, and Fugitive Methane

RNG, biogas and fugitive methane capture have the potential to receive large negative emissions intensities. This is because the methane would otherwise be released into the atmosphere with a 100-year GWP of 28. Capturing this methane and burning it would result in a GWP of 1, a significant reduction in emissions. Treasury’s requests for comment seem to reflect a concern about the possible unintended consequences of crediting such fuels. For example, Treasury specifically requests comment on how to avoid the additional production of waste to generate more RNG. Treasury also suggests it will restrict the use of these fuels to their “first productive use,” meaning that these fuels would not be allowed to receive credit if their sources were already being used productively (and not, say, vented into the atmosphere).

3.3. Carbon Capture

For carbon capture, Treasury requests comment on how to verify the ultimate endpoint of the CO2, whether in geological storage or utilization; what happens if some of the CO2 leaks and how to account for upstream CCS as part of fuel production in an LCA.

With its proposed guidance, Treasury has answered—or at least has started to answer—the major questions regarding the tech-neutral tax credits. The two most significant decisions are likely the choice of consequential life-cycle analysis to determine emissions rates for C&G technologies and the choice to include any upstream combustion and gasification of feedstocks in the determination of a C&G technology.

Besides the areas where Treasury has requested comment, a few open questions remain from our original list, including whether biomass will be able to achieve a zero or negative emissions rate and how a facility is defined. Defining the terms of the LCA and setting up the infrastructure to enable the needed calculations will also be a significant endeavor. The level of burden on applicants to perform consequential LCA analysis is potentially high and may make it challenging for small businesses to qualify.

In this guidance, Treasury has set forth a path for important non-C&G technologies such as wind and solar to continue to qualify for a tax credit. At the same time, it has asked complex and important questions regarding the life-cycle analysis needed to determine the qualification of C&G technologies. These questions deserve careful consideration by stakeholders over the remainder of the 60-day comment period to ensure the success and broader applicability of this new tax credit.