On August 16, 2022, President Biden signed the Inflation Reduction Act of 2022 (the Act). The Act includes multiple tax benefits for hydrogen production, storage and utilization, summarized in the following King & Spalding Client Alert.
This hypothetical is the first in our series designed to provide our observations on the Act’s hydrogen related provisions. Understanding these rules will take time and hopefully many of the ambiguities we see will be resolved by government guidance. In the meantime, these hypotheticals will hopefully answer some basic questions and tease out some issues that need guidance to resolve.
Taxpayer owns and operates a solar or wind farm that is eligible for either the Section 45 production tax credit (PTC) or the Section 48 investment tax credit (ITC).
Encouraged by the Act’s new “clean hydrogen” tax credits, the taxpayer places an order for an electrolyzer and related equipment to split water into hydrogen and oxygen. The electrolyzer and related equipment will be “placed in service” in 2023 and located next to the solar or wind farm within the United States.
Section 45V creates a new 10-year PTC for clean hydrogen. The provision grants tax credits for each kilogram (kg) of “clean hydrogen” produced, defined by reference to the lifecycle carbon dioxide equivalent (CO2e) emissions rate of the production process. This concept is borrowed from the Renewable Fuel Standard provisions of the Clean Air Act. To qualify as clean hydrogen, a process must result in no more than 4 kgs of CO2e per kg of hydrogen produced, calculated using a model sponsored by the Department of Energy's Office of Energy Efficiency and Renewable Energy.
The maximum PTC in 2022 is $3.00 per kg. Hydrogen production qualifies for this rate if: 1) CO2e is less than 0.45 kgs per kg of hydrogen, and, when applicable, 2) the facility satisfies the “prevailing wage” and apprenticeship requirements. Various PTC rates below the maximum apply depending on the CO2e level and whether the wage/apprenticeship standards are met.
Clean hydrogen production facilities can elect the ITC in lieu of the PTC. The ITC has a base rate that varies according to the amount CO2e per kg of hydrogen. A 30% ITC is available if: 1) CO2e is less than 0.45 kgs per kg of hydrogen, and, when applicable, 2) the facility satisfies the “prevailing wage” and apprenticeship requirements. Various ITC rates below the maximum apply depending on the CO2e level and whether the wage/apprenticeship standards are met.
Unlike the PTC, the ITC is also eligible for two potential credit bonuses. These bonus credits are for: 1) satisfying a minimum “domestic content” requirement, and 2) locating the facility within an “energy community.” The bonus credits each equal 10 percentage points and taxpayers can stack credits, meaning the maximum available ITC for the facility should be 50% of qualified investment.
Interaction with Existing Rules
Taxpayers are free to choose either the PTC or ITC for a clean hydrogen facility. A taxpayer may not elect both the PTC and the ITC for the same facility. A clean hydrogen production facility, however, requires a separate election from a solar or wind farm, and the taxpayer may elect a different credit for each. Taxpayers can claim a renewable electricity credit (ITC/PTC) and use electricity from that facility to then generate clean hydrogen and claim a clean hydrogen credit (ITC/PTC).
Clean hydrogen tax credits provide welcome recognition of the role hydrogen can play in the US and global economy. Taxpayers will need to make their own calculations on whether the hydrogen PTC or ITC is right for their circumstances, particularly where a higher than 30% ITC is possible.
Interestingly, the standard PTC (Section 45) now provides for up to 10% bonuses if the taxpayer satisfies either the “domestic content” or “energy community” requirements. These bonus tax credits are not available for Section 45V clean hydrogen production even though the 10 percentage point bonuses are available to a clean hydrogen facility if it elects the ITC instead.
For purposes of discussion, the fact patterns described above have been considerably simplified and many simplifying assumptions have been made. Readers should not construe the contents of this Hypothetical as legal, tax or other advice, and should consult their own tax or legal advisor as to legal, tax and other related matters concerning the Act.