The Risks and Benefits of the IRA’s 45Q, 45Z

Scott Delaney is a partner in the Dallas office of Winston & Strawn, where his practice focuses on corporate transactions for public and private companies, as well as private equity sponsors and their portfolio companies, with a particular emphasis on the energy sector. Samuel Peca and Luke Smith at Winston & Strawn contributed to this article.

The Inflation Reduction Act (IRA) expands the tax credits and other financial incentives available for energy transition and renewable energy projects, which has spurred investment in carbon capture, utilization and storage (CCUS) projects. There are three important legal considerations related to the interaction of Sections 45Z and 45Q under the IRA; however, it is important to recognize that additional credits and tax implications at the federal and state level may also apply.

Section 45Q of the IRA provides a tax credit for qualified carbon oxide (COx) captured and either securely stored in underground geological formations or reused for specified purposes. The credits may be claimed by the taxpayer who owns the carbon capture equipment and ensures (whether physically or contractually) the capture and disposal or utilization of the COx. 45Q credits are available to a qualifying CCUS project for 12 years, beginning when the equipment is placed in service.

Section 45Z of the IRA provides a tax credit for production of low-emissions transportation fuels, including low-carbon ethanol, biodiesel and sustainable aviation fuels. The credits apply to fuels produced and sold from Dec. 31, 2024, through Dec. 31, 2027, and may be claimed by the taxpayer who owns the fuel production plant.

Creating a framework to make elections

CCUS projects may result in eligibility for multiple tax credits (and multiple taxpayers who may claim such credits) under the IRA, particularly when one of the project participants produces sustainable fuels in its ordinary course. The IRA generally prohibits double-dipping on such credits, so project documents must set forth a clear framework to establish the process for making elections between mutually exclusive credits. Elections are made annually, and the IRA permits a participant to toggle between claiming 45Q and 45Z credits (on an annual basis).

The participants may decide, based upon practical considerations, who will take the decision-making role, and so long as the project documents include sufficient specificity as to defining, calculating and comparing each credit’s aggregate economic benefit, then the framework will drive alignment among the parties to maximize overall project value. A few items to consider in regard to the election framework include: information sharing obligations, reporting obligations of the participant making the election and the degree the participants wish to expand the election framework to cover future credits that may replace or extend 45Z credits following their expiration in 2027.

Sharing in the 45Z upside

Because the participants in a CCUS project may toggle between 45Q and 45Z credits during the life of a project, project documents need to contemplate economics for 45Q years and economics for 45Z years.

We have observed a general preference among clients toward setting baseline project economics based upon expected 45Q credit value, and then providing for a sharing of net benefits in the event that 45Z credits are elected in a given year. Participants should consider how each will benefit in any excess value resulting from an election of the higher value credit. If so, the participants must carefully negotiate the allocation and calculation mechanics of this sharing of the upside in coordination with other economic considerations of the project.

Allocating risk of recapture

An important distinction between credits is that 45Q credits are subject to recapture for COx that ceases to be properly captured or used within the recapture period. For example, 45Q credits could be recaptured due to leaks of COx from secure storage or use of sequestered COx for non-qualified uses. 45Z credits are not currently subject to recapture under the IRA. 

For CCUS projects primarily contemplating 45Q credits, participants may be able to obtain insurance and/or indemnity to allocate risks of losses related to the recapture of credits. Participants should consider that insurance and indemnity proceeds may have different tax attributes than the credit proceeds for which they serve as a substitute and whether coverage will be included for leaks of COx stored in the current year (in which case fewer credits may be claimable, but there is no recapture of credits previously claimed).

The tax incentives in the IRA provide an exciting opportunity for project developers in the clean energy industry in the U.S., but also create new types of uncertainty and risk. Participants in CCUS projects should ensure that project documents are clearly drafted to delineate the rights and economic interests of each participant with respect to available tax credits and allocate the inherent risks.