In response to a series of questions posed in a November 2019 letter from Senator Menendez (D-NJ), the Treasury Inspector General for Tax Administration (TIGTA) issued a letter on April 15, 2020, analyzing carbon oxide credits under Internal Revenue Code (IRC) section 45Q. For tax years between 2010 and 2019, TIGTA found that up to 87% of the value of the credits claimed were not in compliance with Environmental Protection Agency (EPA) monitoring, reporting, and verification requirements.

IRC section 45Q provides a credit to taxpayers that capture and sequester carbon oxide. The credit was initially enacted into law in 2008, then substantially revised in 2018. As part of the revisions, the credit was expanded from solely carbon dioxide capture to include a broader set of carbon oxide emissions. This substantially expanded the class of taxpayers eligible to claim the credit. Although Treasury released some guidance in February 2020, there are still many unresolved questions about the expanded carbon oxide credit, and many taxpayers are waiting to move forward with additional projects pending release of that guidance.

The TIGTA analysis covers tax years 2010–2019, so it will primarily include carbon dioxide projects. The letter reports that only 10 out of the 672 taxpayers who claimed the IRC section 45Q credit received over $1 million in credits, and these 10 taxpayers represent 99.86% of the total value of all IRC section 45Q credits, around $1.02 billion. An examination of return data found that 87% of the credits claimed by these 10 taxpayers may have been improper because there was not an approved EPA monitoring, reporting, and verification plan in place when the credits were claimed. TIGTA reported that the IRS had already taken action against 4 of these 10 taxpayers—disallowing approximately 60% of the improperly claimed credits. Additional enforcement activity may target taxpayers who claimed large amounts of carbon sequestration credits.

Practice Point: Taxpayers considering investing in carbon oxide sequestration projects should perform extensive diligence on the project and make sure that they technically meet the requirements. We expect that carbon sequestration projects may come under increased scrutiny and result in more audits going forward. Spending the time and resources to ensure that your project conforms to the rules will save you money if the IRS denies your credits. Additionally, make sure to contemporaneously document your efforts to follow the rules; this may assist in penalty abatement if asserted.

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