Treasury and IRS Publish Much-Anticipated Guidance on Clean Hydrogen Tax Credit

The Internal Revenue Service (IRS) and the US Department of the Treasury (Treasury) recently published proposed regulations (Proposed Regulations) setting forth rules applicable to the credit for the production of clean hydrogen and the election to treat clean hydrogen production facilities as energy property under Sections 45V and 48(a)(15) of the Internal Revenue Code (Code) enacted under the Inflation Reduction Act of 2022 (IRA).

The Proposed Regulations provide much-anticipated guidance regarding eligibility for and the requirements for claiming the two types of clean hydrogen federal income tax credits. Among the most sought-after guidance, the Proposed Regulations address the use of energy attribute certificates (EACs), such as renewable energy certificates (RECs), to support a project’s clean hydrogen emissions profile (e.g., for hydrogen produced from electrolyzers powered by electricity sourced from the grid).

The approach taken in the Proposed Regulations would resolve many of the most pressing issues as to credit qualification, albeit in a manner that is more restrictive than many stakeholders had hoped. However, Treasury and the IRS do include broad requests for comments as to whether or how some of these aspects of the Proposed Regulations could be relaxed.

Taxpayers may generally rely on the rules set forth in the Proposed Regulations for taxable years beginning after December 31, 2022, and before the release of final regulations.

BACKGROUND ON HYDROGEN PTC/ITC

The IRA enacted a new tax credit for US-produced clean hydrogen under both Section 45V of the Code and Section 48 of the Code. The Section 45V credit is a production tax credit (PTC) for qualified clean hydrogen produced after 2022 at a qualified clean hydrogen production facility (the construction of which begins prior to January 1, 2033) during the 10-year period beginning on the date the facility is originally placed in service.

Qualified clean hydrogen must, in addition to meeting a lifecycle greenhouse gas (GHG) emissions rate standard, be produced (1) in the United States or a possession of the United States, (2) in the ordinary course of a trade or business of the taxpayer, and (3) for sale or use. The production and sale or use of the hydrogen must be verified by an unrelated party.

The IRA amended the Section 48 investment tax credit (ITC) to permit a taxpayer that owns a qualified clean hydrogen production facility placed in service after December 31, 2022, to make an election to claim the ITC in lieu of the Section 45V PTC.

Eligibility for, and the amount of the hydrogen PTC and ITC (as depicted in the table below), depends on the applicable lifecycle GHG emissions rate of the applicable facility associated with the facility’s hydrogen production process. The base rate of the hydrogen PTC and ITC is generally divided into the following four levels:

*Rates subject to adjustment based on 2022 base year inflation factor.

The above base rates are multiplied by five (as depicted in the table below) if the taxpayer either (1) begins construction on the facility prior to January 29, 2023, and any alteration or repair of the facility that occurs after such date meets the prevailing wage and apprenticeship (PWA) requirements, or (2) if the taxpayer satisfies the PWA requirements with respect to the facility’s construction and alteration and repair.

*Rates subject to adjustment based on 2022 base year inflation factor.

The Code defines lifecycle GHG emissions as follows:

1. In general: Subject to subparagraph (B), the term “lifecycle greenhouse gas emissions” has the same meaning given such term under subparagraph (H) of section 211(o)(1) of the Clean Air Act (42 USC 7545(o)(1)), as in effect on the date of enactment of this section.
2. GREET model: The term “lifecycle greenhouse gas emissions” shall only include emissions through the point of production (well-to-gate), as determined under the most recent Greenhouse gases, Regulated Emissions, and Energy use in Transportation model (commonly referred to as the “GREET model”) developed by Argonne National Laboratory, or a successor model (as determined by the Secretary [of Treasury]).

Credits claimed under Section 45V are eligible for the IRA’s new monetization methods as follows: (1) through “direct payment” under Section 6417 of the Code for those types of entities generally eligible for this method of monetization (e.g., tax-exempt and governmental entities); (2) through “direct payment” under Section 6417 of the Code for five years for those types of entities not generally eligible for such monetization approach (e.g., taxable entities); and (3) through a credit transfer under Section 6418 of the Code.

The hydrogen ITC is eligible to be monetized in an identical manner other than with respect to the foregoing approach (2).

THE PROPOSED REGULATIONS

The Proposed Regulations would generally provide rules for (1) determining lifecycle GHG emissions rates resulting from hydrogen production processes (including the utilization of EACs); (2) petitioning for provisional emissions rates; (3) verifying production and sale or use of clean hydrogen; (4) modifying or retrofitting existing qualified clean hydrogen production facilities; (5) using electricity from certain renewable or zero-emissions sources to produce qualified clean hydrogen; and (6) electing to treat part of a specified clean hydrogen production facility as property eligible for the ITC.

The Proposed Regulations cover a wide range of topics, while also requesting comments from the public in a variety of areas. The below highlights certain material aspects of the Proposed Regulations.

Hydrogen-Specific GREET Model to Determine Lifecycle GHG Emissions Rate on a Yearly Basis

The Proposed Regulations would determine the lifecycle GHG emissions rate for the production of hydrogen based on a hydrogen-tax-credit-specific version of the GREET model for calculating “well-to-gate” emissions. The Proposed Regulations would confirm that this well-to-gate measurement encompasses emissions through the point of production, including emissions associated with feedstock growth, gathering, extraction, processing, and delivery to a hydrogen production facility as well as emissions associated with the hydrogen production process, inclusive of the electricity used by the hydrogen production facility and any capture and sequestration of carbon dioxide generated by the hydrogen production facility.

A taxpayer must make this determination following the close of each taxable year and must include all hydrogen production during such period. Accordingly, the Proposed Regulations do not contemplate a project being eligible for Section 45V PTCs at a particular level with respect to some production where its lifecycle GHG emissions rate varies outside of a specific tier (as depicted in the tables above) during the taxable year.

The hydrogen-specific GREET model, 45VH2-GREET, is available at www.energy.gov/45vresources. It currently includes pathways for a variety of hydrogen production technologies, including electrolysis, steam methane reforming of natural gas or landfill gas, autothermal reforming of natural gas or landfill gas, coal gasification, and biomass gasification. The pathways using fossil fuels or biomass also provide for potential carbon capture and storage. The US Department of Energy (DOE), which administers the GREET model, anticipates developing pathways for additional hydrogen technologies in the future. However, any request submitted to the DOE to establish a provisional emissions rate for a hydrogen production approach not addressed by 45VH2-GREET must generally apply 45VH2-GREET conventions and principles.

The inputs for a 45VH2-GREET model predominantly depend on the type of technology employed to generate hydrogen, the associated feedstock and potentially associated carbon capture and sequestration equipment and impact. The 45VH2-GREET model then determines the lifecycle GHG emissions rate based on a variety of fixed assumptions that may not be altered, such as upstream methane loss rates, emissions associated with power generation from specific generator types, and emissions associated with regional electricity grids. Although not explicit in the Proposed Regulations, the currently available 45VH2-GREET model effectively tests the purity of produced hydrogen and treats any carbon-containing impurities in the gas stream as producing carbon dioxide emissions in the well-to-gate GHG emissions of hydrogen production.

45VH2-GREET differs from other versions of GREET developed by the DOE in important ways. First and foremost, the “well-to-gate” boundary means that it does not assess some emissions included in other versions of the model. There are also some pathways included in other GREET versions that are not currently available in 45VH2-GREET, including reformation of RNG from municipal solid waste or food waste diverted from landfills, methane pyrolysis, and gasification of certain types of biomass. Further, there are some significant assumptions made in 45VH2-GREET that are not made in other contexts.

As one example, 45VH2-GREET does not assess where any indirect land use change (ILUC) can be attributed to growing biomass, on the assumption that any such change is likely to be minimal. That assumption stands in contrast to modeling used for other tax credits and fuels programs, including the Renewable Fuel Standard program under Section 211 of the Clean Air Act, which Section 45V cross-references.

IRS and Treasury are seeking public comment on various aspects of the 45VH2-GREET model, so the model may change when the final regulations are issued. The DOE also anticipates updating 45VH2-GREET on an annual basis.

‘Three Pillar’ Compliance for Use of Electrical Power

One of if not the most critical (and the most controversial) questions for which Treasury and IRS guidance had been sought was the extent to which EACs, such as RECs, could be applied to support the credit-eligible production of hydrogen and the mechanics of such application.

While the industry generally expected that EACs could be used to support the credit-eligible production of hydrogen (including based on a colloquy on the Senate floor confirming such approach), the critical question has been how the so-called “three pillars” of the use of EACs to evidence emissions reductions—incrementality, temporal matching, and deliverability—would be addressed.

The Proposed Regulations’ approach would be to require relatively strict three-pillar compliance for facilities using electricity to produce hydrogen to qualify for hydrogen credits. This means that all facilities producing hydrogen through electrolysis, whether “in front of the meter” (pulling power from the grid) or “behind the meter” (pulling power from a directly interconnected energy production facility), would be required to procure and retire qualifying EACs to substantiate their lifecycle GHG emissions rates (or else be subject to the general electrical-grid-specific emissions rate in the GREET model).

The Proposed Regulations would credit EACs-to-power consumption of a hydrogen production facility on a 1-to-1 basis regardless of whether the generating facility is behind or in front of the meter, although the IRS and Treasury solicit comments as to whether a different treatment would be more appropriate to account for transmission and distribution line losses. The following discusses the Proposed Regulations’ approach on incrementality, temporal matching, and deliverability. The IRS and Treasury are continuing to solicit comments on different options regarding implementation of each of these three pillars.

• Incrementality (Additionality) – EACs can satisfy the Proposed Regulations’ incrementality requirements in one of two ways. The first is if the hydrogen facility utilizing EACs is placed in service within 36 months after the commercial operation date for the power generation project. The second is if the electricity represented by the EAC is produced by a generating facility that had an “uprate” (i.e., an increase in rated nameplate capacity) no more than 36 months before the hydrogen project was placed into service. The IRS and Treasury are also seeking comments on satisfying the incrementality requirement by obtaining EACs from higher generating facilities that may make upgrades to deliver minimal emitting electricity. The IRS and Treasury also include a very extensive request for comments on additional options to satisfy the incrementality requirement in ways that, in their view, do not result in significant induced GHG emissions, including the following:
  • Obtaining EACs from an energy-generating facility that would otherwise retire but for its relationship with a hydrogen production facility
  • A modeled approach that would cover EACs obtained (1) during periods in which minimal-emitting generation would have otherwise been curtailed or experienced negative energy pricing, and (2) in locations where grid-electricity is 100% generated by minimal-emitting generators or where increases in load do not increase grid emissions—for example, due to state policy capping total GHG emissions such that new load must be met with minimal-emitting generators
  • A formulaic approach that would allow for a specified percentage (currently proposed at 5%, but seeking feedback on alternatives) of generation from minimal-emitting resources placed in service before January 1, 2023.
• Temporal Matching – The Proposed Regulations would require that, until December 31, 2027, electricity represented by the EAC be generated in the same calendar year that the taxpayer’s hydrogen production facility uses electricity to produce hydrogen. However, beginning on January 1, 2028, hourly matching would be required (i.e., the electricity represented by the EAC would need to be generated in the same hour as the electricity utilized by the hydrogen production facility to produce hydrogen). The transition period from annual to hourly matching was proposed in recognition of the fact that only two of the nine EAC tracking systems recognized under the regulations, PJM-GATs and M-RETs, currently provide for hourly tracking, and functionality is still somewhat limited in those systems. For other EAC tracking systems, NAR estimated it could implement hourly tracking within a year; MIRECs, NEPOOL-GIS, and NYGATS estimated they could implement hourly tracking within one to two years; WREGIS estimated it could implement hourly tracking in three to five years; and ERCOT and NC-RETs declined to give a timeline on developing hourly tracking. In addition, while some corporate offtakers have moved toward hourly matching when securing EACs through bilateral virtual power purchase agreements, there is not currently a robust market for hourly EACs. The IRS and Treasury are soliciting comments on the proposed transition period, the predicted timelines for the development of hour tracking mechanisms, and the predicted timeline for market development for hourly EACs.
• Deliverability (Regionality) – The reference energy generation facility must be included in the same geographic region as the hydrogen production facility (based on the National Transmission Needs Study that was released by the DOE on October 30, 2023).

The EAC requirements may lead to further competition in an already-competitive field to secure offtake agreements from renewable energy projects. Average power purchase agreement prices have steadily increased since 2020 and demand for renewable projects remains very strong among corporate offtakers and utilities.

It can be particularly challenging to find development-ready projects in certain markets, such as PJM, where projects are more likely to face permitting and interconnection challenges. However, depending on how the final rules address incrementality, the EAC requirements may also incentivize the expansion of existing projects.

Section 45V PTC Election Timing

The Proposed Regulations specify that Section 45V PTCs would be determined for the taxable year during which the qualified clean hydrogen is produced by the taxpayer, but that the associated election may not be claimed until the sale or use of the relevant hydrogen (and verification thereof) occurs, even if in a later taxable year (with the election made on an amended return for the hydrogen production year).

Without further coordinating guidance, this has the potential to complicate the sale or direct payment of Section 45V PTCs because each such monetization election must be filed with the original tax return for the year in which the credit is produced.

Anti-Abuse Rule

No Section 45V PTC is allowed if “the primary purpose of the production and sale or use of qualified clean hydrogen is to obtain the benefit of the Section 45V credit in a manner that is wasteful, such as the production of qualified clean hydrogen that the taxpayer knows or has reason to know will be vented, flared, or used to produce hydrogen.” This is a facts-and-circumstances determination.

Documentation/Verification

As noted above, the Code requires verification by an unrelated party for production and sale or use of hydrogen to constitute qualified clean hydrogen. The Proposed Regulations provide extensive rules regarding “verification reports” that must be attached to the IRS election form in respect of each qualified clean hydrogen production facility and for each taxable year in which Section 45V credits are claimed by a taxpayer. The verification report must be prepared under penalties of perjury by an “qualified verifier”—an individual or organization with active accreditation from the American National Standards Institute National Accreditation Board or the California Air Resources Board Low Carbon Fuel Standard program.

The verification report must include

• an attestation that the qualified clean hydrogen was in fact produced during the applicable tax year (a “production attestation”),
• an attestation that the qualified clean hydrogen has actually been sold or used as required by Section 45V (a “sale or use attestation”),
• an attestation that demonstrates the qualified verifier’s independence from the taxpayer (a “conflict attestation”),
• identifying and qualification information regarding the qualified verifier (a “qualified verifier statement”),
• certain general information about the taxpayer’s hydrogen production facility, and
• any documentation necessary to substantiate the verification process.

These same documentation/verification requirements generally apply to hydrogen ITC. Taxpayers are required to obtain an annual verification report for the taxable year in which the ITC election is made and for each taxable year thereafter of the applicable recapture period (discussed below).

The substance of these documentation/verification requirements to be attested or substantiated is described in detail in the Proposed Regulations.

Emissions-Based Recapture for Hydrogen ITC

The Proposed Regulations provide for a special recapture rule for the hydrogen ITC where an emissions tier recapture event occurs during the specified recapture period. An emissions tier recapture event occurs during any taxable year of the recapture period if either (1) the taxpayer fails to provide an applicable annual verification report in a timely manner; (2) the specified clean hydrogen production facility actually produces hydrogen through a process that results in a higher tier lifecycle GHG emissions rate than the one initially reported for the year the facility was placed in service; or (3) the specified clean hydrogen production facility actually produces hydrogen through a process that results in a lifecycle GHG emissions rate of greater than 4 kilograms of CO2e per kilogram of hydrogen.

The emissions tier recapture period begins on the first date of the first taxable year after the taxable year in which the facility was placed in service and ends on the last day of the fifth taxable year after the close of the taxable year in which the facility was placed in service. Thus, the recapture period for a calendar-year taxpayer that places a clean hydrogen production facility in service on June 1, 2023, is January 1, 2024 through December 31, 2028. Critically, this recapture period exceeds the five-year-after-placed-in-service recapture period that applies with respect to other ITC recapture events (e.g., recapture attributable to a disposition of ITC property or the failure to meet prevailing wage requirements).

The potential emissions tier recapture amount for each year during the five-year recapture period is 20% of the total ITC amount.