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 second in our series designed to provide our observations on the Act’s hydrogen related provisions. It will take time to understand the implications of the new law and the inevitable implementing IRS/Treasury guidance. Hopefully, many of the ambiguities we see currently will be resolved by that guidance. In the meantime, these hypotheticals are intended to 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/wind farm within the United States.
The taxpayer orders new storage tanks to hold the hydrogen produced by the electrolyzer. It may sell the stored hydrogen to third parties or use it to power a fuel cell to generate electricity it sells onto the grid. The storage tanks need a compressor to store the hydrogen at high pressures. The storage tanks and related equipment will be placed in service at the same time and place as the electrolyzer.
Hydrogen Storage ITC
The Act adds “energy storage technology” to the types of energy property eligible for the standard ITC under Section 48. The definition of energy storage is not a model of legislative clarity.1Section 48(c)(6)(A)(i) (“property (other than property primarily used in the transportation of goods or individuals and not for the production of electricity) which receives, stores, and delivers energy for conversion to electricity (or, in the case of hydrogen, which stores energy), and has a nameplate capacity of not less than 5 kilowatt hours”). That hydrogen storage is specifically mentioned as a qualifying purpose suggests that hydrogen need not be for the “conversion to electricity” and includes, simply, the storage of hydrogen. But hydrogen storage for any and all purposes may be more than was intended. So, clarification by IRS/Treasury would be helpful.
An inclusive interpretation for hydrogen storage is preferable and hopefully the one adopted by IRS/Treasury as they write guidance on this provision. Hydrogen’s utility as an energy source extends well beyond simply the generation of electricity. It can replace fossil fuels in key carbon-intensive industries, including the production of concrete, glass and steel2 Hydrogen’s utility goes well beyond being an energy source. The chemical and petroleum industries are some of the largest consumers of hydrogen for non-energy uses today. Its most infamous non-energy use is for lighter than air buoyancy in airships (i.e., zeppelins). Significantly, hydrogen combustion engines deliver mechanical and not electrical energy. Many manufacturers are considering hydrogen combustion engines instead of fuel cells for certain equipment and limiting hydrogen’s role to only generating electricity ignores this important alternative energy use. and a narrow interpretation of hydrogen storage as a mere battery substitute would certainly impede important carbon reduction goals the Act is meant to achieve.
A 30% ITC is available if the storage project satisfies the 5X multiplier provision in Section 48. The 5X multiplier is generally available if: 1) the storage project “begins construction” no later than 59 days after the IRS/Treasury publish guidance on the “prevailing wage” and apprenticeship requirements, or 2) the project begins construction after this date and both the prevailing wage and apprenticeship requirements are satisfied. Even for early projects satisfying the first condition, the prevailing wage concept will apply to certain alterations or repairs occurring within the five-year period beginning on the date the project is placed in service.
The energy storage 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 a maximum of 10 percentage points and taxpayers can stack credits, meaning the maximum available ITC for the facility should be 50% of qualified investment.
Interaction with Other Rules
In our hypothetical, hydrogen storage serves as the critical bridge from the creation of green hydrogen to its ultimate use. One area of uncertainty is whether hydrogen storage property is separate energy property for ITC purposes if connected to a clean hydrogen production facility. If the clean hydrogen facility elects the Section 45V PTC, does that preclude the storage receiving the green hydrogen from receiving an ITC? The better answer is no. This interpretation aligns with descriptions of the credit being available for “stand-alone energy storage” and the broader statutory scheme permitting the ITC/PTC election for renewable electricity generation to be independent of the clean hydrogen ITC/PTC election. Ideally, IRS/Treasury guidance will resolve this issue in taxpayers’ favor soon.
Storage technology is a critical element in promoting the generation and deployment of green hydrogen. The new ITC for energy storage technologies is a great step in the right direction. However, IRS/Treasury need to quickly address many critical questions regarding the scope of the ITC for hydrogen storage.
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.