In-Depth: Understanding New Proposed Regulations for Clean Hydrogen

By Carl F. Staiger, with specific insights from Sean Moran and Heather Hurst.

On December 22, 2023, the Treasury Department and Internal Revenue Service (IRS) issued proposed regulations regarding the clean hydrogen production credit (PTC) under §45V of the Internal Revenue Code (IRC) and the election to treat clean hydrogen production facilities as energy property for purposes of the IRC §48 investment tax credit (ITC). The proposed regulations, which were published in the Federal Register on December 26, 2023, would affect all taxpayers who produce hydrogen and claim the clean hydrogen production credit, elect to treat part of a specified clean hydrogen production facility as ITC-eligible property or produce electricity from certain renewable or zero-emissions sources used by taxpayers or related persons to produce qualified clean hydrogen.¹

Simultaneously with the release of the proposed regulations, the Department of Energy (DOE) provided guidance in the form of a white paper, emissions model and accompanying user manual assessing lifecycle greenhouse gas emissions associated with electricity use for the §45V credit.

This article represents a high-level summary of certain key provisions within the proposed regulations, as supplemented by the DOE Guidance.

Background

Federal tax provisions were added or amended under the Inflation Reduction Act of 2022 (IRA) to, among other things, incentivize expansion of the hydrogen economy. Some of these provisions directly incentivize the use of hydrogen to fuel our vehicles and power our homes and businesses. For example:

• IRC §30D and §45W provide a tax credit to taxpayers for purchasing and placing into service a “new clean vehicle” and “qualified commercial clean vehicle”, respectively, including a “fuel cell” electric vehicle powered by hydrogen.
• To support the vehicle credits, IRC §30C provides taxpayers with a credit for purchasing and installing clean vehicle charging or “alternative fuel” refueling equipment.²
• IRC §25D provides a taxpayer with a “residential clean energy” tax credit for a “qualified fuel cell property expenditure” installed on or in connection with a principal residence.
• To incentivize manufacturing of these products, IRC §45X provides an “advanced manufacturing production credit” for “eligible components,” including qualifying battery components (e.g., battery modules for a hydrogen fuel cell vehicle), that are produced by a taxpayer in the United States and sold to an unrelated taxpayer.

These provisions provide an illustration of some of the tax benefits, as well as applications and opportunities, available on the demand side of the hydrogen economy that goes beyond other known commercial applications, including the production of fertilizers, iron and steel. In order to fuel the growth of the hydrogen economy, however, there must be a significant supply-side investment in hydrogen production facilities and related infrastructure. Specifically, there must be a sufficient economic incentive to invest in facilities needed to produce hydrogen from various sources (known as production pathways), including facilities needed to produce “green hydrogen” (i.e., hydrogen produced via water electrolysis, using electricity, including electricity produced from renewable sources such as wind and solar), “blue hydrogen” (i.e., hydrogen produced from natural gas, whereby the carbon oxide is captured and sequestered), “grey hydrogen” (i.e., hydrogen produced from natural gas without capturing and sequestering carbon oxide), and whereby the carbon oxide being captured and sequestered). That’s where the Biden administration is hoping IRC §45V and IRC §48 come into play.

What is the Clean Hydrogen Production Credit under Section 45V?

Calculation of the PTC

Under IRC §45V, as amended by the Inflation Reduction Act of 2022 (IRA), taxpayers may claim PTC for the production of qualified clean hydrogen. Subject to the increased credit amount under the IRA (discussed below), the PTC for any taxable year is an amount equal to the product of (i) the kilograms of “qualified clean hydrogen” produced by the taxpayer during such taxable year at a “qualified clean hydrogen production facility” during the 10-year period beginning on the date such facility was originally placed in service, and (ii) the “applicable amount” as determined under IRC §45V(b) with respect to such hydrogen. The applicable amount is an amount equal to the “applicable percentage” of up to $0.60 per kilogram or up to $3.00 per kilogram if the IRA requirements for the increased credit amount are satisfied – see below. The “applicable percentage” gradually increases based upon the lifecycle greenhouse gas emissions (lifecycle GHG emissions) rate of the process to produce any qualified clean hydrogen as follows:³

Increased Credit Amount

As amended by the IRA, the credit amount is multiplied by five with respect to a qualified clean hydrogen production facility if:

• The beginning of construction (BOC Exception) for such facility commenced before January 29, 2023,
• The facility satisfies the “one-megawatt exception” (i.e., it is a project with a maximum net output of less than 1 megawatt of electrical (as measured in alternating current) or thermal energy determined based on the nameplate capacity), or
• The facility satisfies the prevailing wage and apprenticeship (PWA Requirements).⁴

To satisfy the PWA Requirements, (i) wages paid during the construction of the facility must not be less than the prevailing rates for construction, alteration, or repair of a similar character in the locality in which such facility is located, as determined under the Davis Bacon Act, and (ii) apprenticeship requirements described in Prop. Reg. §1.45-8 and the recordkeeping requirements described in Prop. Reg. §1.45-12 are satisfied.

Qualified Clean Hydrogen

Under IRC §45V, “qualified clean hydrogen” is produced through a process that results in a lifecycle GHG emissions rate of not greater than 4 kilograms of CO2e per kilogram of hydrogen and such hydrogen (i) is produced in the United States or a United States territory, in the ordinary course of a trade or business of the taxpayer, and for sale or use; and (ii) the production and sale or use of such hydrogen are verified by an unrelated party.

Coordination with IRC §45Q

No PTC credit is allowed with respect to any qualified clean hydrogen produced at a facility that includes carbon capture equipment for which a credit is allowed to any taxpayer as determined under IRC §45Q (Carbon Oxide Sequestration Credit) for the taxable year or any prior taxable year.

Election to Treat Clean Hydrogen Production Facilities as Energy Property under IRC §48

IRC §48(a)(15) provides that in the case of any qualified property that is part of a specified clean hydrogen production facility, such property is treated as “energy property,” and a taxpayer may make an irrevocable election to claim the ITC under IRC §48 with respect to such property.⁵  IRC §48(a)(15)(A)(ii) provides that the energy percentage for a facility that is designed and reasonably expected to produce qualified clean hydrogen with a lifecycle GHG emissions rate that is within Emissions Tiers 1, 2, 3 or Tier 4 (described above), is 1.2%, 1.5%, 2% and 6% respectively.

Note: The energy percentage is multiplied by five if the facility either (i) satisfies the BOC Exception, (ii) satisfies the “one-megawatt exception,”⁶ or (iii) satisfies the PWA requirements.

Note: The election is irrevocable and is in lieu of any production credit under §45V and §45Q relative to the energy property (i.e., clean hydrogen production facility) for which an election is made.

Guidance under the Proposed Regulations

1. Defined Terms

The proposed regulations expand upon and provide additional clarity to a number of key definitions beyond the statutory language that directly impact the eligibility determination for, and the amount of, the PTC:

Facility. Clarifying that “facility” is a single production line used to produce qualified clean hydrogen. A “single production line” includes all property components that function interdependently to produce qualified clean hydrogen. These components are functionally interdependent if the placing in service of each component is dependent upon the placing in service of each of the other components to produce qualified clean hydrogen. “Facility” does not include equipment used to condition or transport hydrogen beyond the point of production or electricity production equipment used to power the hydrogen production process, including any carbon capture equipment associated with the process.

Lifecycle Greenhouse Gas Emissions; GREET Model. The proposed regulations incorporate the statutory definition of the term “lifecycle greenhouse gas emissions” under IRC §45V(c)(1)(A) and (B), specifically provide that the term has the same meaning under the Clean Air Act as in effect on August 16, 2022, and includes emissions only through the point of production (well-to-gate) as determined under the most recent “GREET model” (meaning the latest version of it developed by Argonne National Laboratory (ANL) that is publicly available on the first day of the taxpayer’s taxable year in which the qualified clean hydrogen was produced.

Provisional Emission Rates. IRC §45V(c)(2)(C) provides that in the case of any hydrogen for which a lifecycle greenhouse gas emissions rate has not been determined via the GREET model, an affected taxpayer may file a petition with the Treasury for determination of the lifecycle greenhouse gas emissions rate with respect to such hydrogen. “Provisional emissions rate” or “PER” means the lifecycle GHG emissions rate of the process as determined by the Treasury.

Qualified Clean Hydrogen. The statutory terms (described above) are incorporated by the proposed regulations. In addition, regulations clarify that the term “for sale or use” means for the primary purpose of making such hydrogen ready and available for sale or use. Storage of hydrogen before its sale or use would not disqualify such hydrogen from being considered produced for sale or use.

Energy Attribute Certificates (EACs). The term “EACs” refers solely to EACs that represent attributes of electricity generated by a specific facility or source. They are used to substantiate the purchase of electricity from zero greenhouse gas (GHG)-emitting sources and, as stated below, can be used to quantify indirect emissions associated with electricity for the PTC. EAC means a tradable contractual instrument issued through a qualified EAC registry or accounting system, including renewable energy certificates (RECs) and other similar energy certificates issued through a registry or accounting system.

Commercial Operations Date (COD). Relevant to EACs, the proposed regulations define the term “commercial operations date” (COD) as the date on which a facility that generates electricity begins commercial operations.

Emissions through the point of production (well-to-gate). The term “emissions through the point of production (well-to-gate)” means the aggregate lifecycle GHG emissions related to hydrogen produced at a hydrogen production facility during the taxable year through the point of production. It includes emissions associated with feedstock growth, gathering, extraction, processing, and delivery to a hydrogen production facility. It also includes the emissions associated with the hydrogen production process, including the electricity used by the hydrogen production facility and any capture and sequestration of carbon dioxide generated by the hydrogen production facility.

2. Procedures for Determining Lifecycle Greenhouse Gas Emission Rates

Generally. Proposed §1.45V-4(b) outlines the calculation of the lifecycle GHG emissions rate using the most recent GREET model. Taxpayers claiming the §45V credit must determine the rate separately for each hydrogen production facility they own for each taxable year. The taxpayer must accurately enter all relevant inputs about their qualified clean hydrogen production facility in the 45VH2-GREET model following the Guidelines to Determine Well-to-Gate Greenhouse Gas (GHG) Emissions of Hydrogen Production Pathways using 45VH2-GREET (GREET User Manual).

Hydrogen Production Pathways. The GREET model contemplates the following hydrogen production pathways: steam methane reforming (SMR) of natural gas with potential carbon capture and sequestration (CCS), Autothermal reforming (ATR) of natural gas with potential CCS, SMR of landfill gas with potential CCS, Coal gasification with potential CCS, Biomass gasification with corn stover and logging residue (with no significant market value with potential CCS), Low-temperature water electrolysis using electricity, and High-temperature water electrolysis using electricity and potential heat from nuclear power plants. The model also includes fixed assumptions called "background data," which users cannot change. Despite its defense of the assumptions in the DOE Guidance, the GREET model requires inputs to determine the lifecycle of emissions based on assumptions (e.g., methane leakage during natural gas recovery, combustion emissions at compressors or generation facilities) that are currently difficult to independently verify (and at times actively disputed by industry players). These inputs could impact the amount of credit received or even impact eligibility for the more carbon-intensive hydrogen production pathways. For example, the GREET User Manual sets out emissions factors as follows, with higher emissions factors for the natural gas and other fossil fuel pathways:

The Treasury Department and the IRS are seeking comments on the readiness of verification mechanisms for certain background data.

Observation: Industry players will likely be motivated to comment to ensure the applicable factors properly reflect their production process and emissions.

Eligibility to Use the PER Process. The proposed regulations provide that a taxpayer cannot file a petition for a PER if a lifecycle GHG emissions rate has already been determined for hydrogen produced by the taxpayer at a hydrogen production facility, according to the most recent GREET model. This means that if the feedstock (e.g., a type of biomass not represented in the model) or hydrogen production technology used by the facility (e.g., technologies used to drill for geologic hydrogen or trigeneration that can use a fuel cell to co-produce hydrogen, heat, and power) is not included in the most recent GREET model, the taxpayer may use the PER process to obtain carbon intensities determinations. If the feedstock and production technology are already represented in the model, even if the taxpayer disagrees with the assumptions or calculation approach used, the taxpayer cannot use the PER process.

Observation: This static determination will likely prove controversial for taxpayers producing hydrogen by employing a traditional process that is more carbon intensive, such as blue hydrogen and grey hydrogen (derived from natural gas sources), particularly taxpayers in regions where geologic CCS is not yet proven and available (e.g., Appalachia).

Filing a Petition. A PER petition must be attached to a taxpayer’s federal income tax return or information return for the first taxable year of hydrogen production within the 10-year period covered by §45V(a)(1). The PER petition must include, among other things, an emissions value obtained from the DOE, which assesses the lifecycle GHG emissions rate associated with the facility's hydrogen production pathway. The proposed regulations provide that the DOE emissions value request process will be available starting April 1, 2024.

Effect of PERs. A taxpayer can use a PER determined by the Treasury to calculate the clean hydrogen production credit under §45V and for qualified clean hydrogen produced at a qualified clean hydrogen production facility starting from the first taxable year in which the PER is obtained and for any subsequent taxable year within the 10-year period since the facility was placed in service, as long as all other requirements of §45V are satisfied.

Use of EACs. The proposed regulations provide that the Treasury Department and the IRS, in consultation with the EPA and the DOE, have determined that EACs can be used to document purchased electricity inputs and assess emissions impacts of electricity used in hydrogen production for the §45V credit. The proposed regulations and DOE Guidance outline the detailed requirements for EACs to be considered “eligible EACs,” including detailed rules for “incremental generation,” “temporal matching” and “geographic matching” (also known as “deliverability”). Incremental generation or “incrementality” requires that the EACs represent incremental source electricity (i.e., electricity from a newer electricity generating facility that has a recent COD no more than 36 months prior to the date the hydrogen facility was placed in service or increased capacity from an older electricity generating facility that has been “uprated.”) Prior to January 1, 2028, an EAC satisfies the temporal matching requirement if the electricity represented by the EAC is generated in the calendar year that the taxpayer’s hydrogen production facility uses electricity to produce hydrogen. After January 1, 2028, an EAC satisfies the temporal matching requirement if the electricity represented by the EAC is generated in the same hour that the taxpayer’s hydrogen production facility uses electricity to produce hydrogen. The proposed regulations provide that an EAC satisfies the “geographic matching” or “deliverability” attribute and may be counted if the electricity represented by the EAC is generated by a facility that is in the same region as the hydrogen production facility, with each “region” being defined by the DOE in its October 2023 National Transmission Needs Study. The proposed regulations provide that the acquisition and retirement of EACs must be recorded in a qualified EAC registry or accounting system for verification by a qualified verifier.   

Request for Comments. The Treasury and IRS are seeking comments as to a number of issues relevant to EACs, including key concepts impacting incrementality, temporal matching and deliverability. Among other things, the Treasury and IRS are seeking input on two specific types of electricity generation for which GHG emissions can be highly variable or uncertain: (i) fossil fuel-powered electricity generation with CCS and (ii) biomass-powered electricity generation, including mechanisms to verify accurately real-world emissions related to hydrogen production. This would include mechanisms for, among other things, verification of the origin of the feedstock, rate of carbon capture and other parameters that are relevant to accurate lifecycle analysis, as well as the ability of EAC instruments to represent such attributes accurately. In addition, the Treasury and IRS are considering alternative approaches to identifying circumstances in which there is minimal risk of significantly induced grid emissions for certain existing electricity-generating facilities.

3. Procedures for Verification of Production and Sale and Use

Verification Report. The proposed regulations outline the requirements for verification reports and attestations to be attached to the taxpayer’s IRS Form 7210 and included with their federal income tax return or information return. The verification report must be prepared by a qualified verifier under penalties of perjury and include various types of information, including attestation regarding the taxpayer’s production of qualified clean hydrogen, the amount of hydrogen sold or used, conflicts of interest, and documentation of the verifier’s qualifications. The report should also include any necessary documentation to substantiate the verification process based on the standards and best practices prescribed by the accrediting body of the verifier and the circumstances of the taxpayer and their hydrogen production facility.

Qualified Verifier. The proposed regulations require that the production and sale or use of such hydrogen must be verified by a “qualified verifier” who, among other things, is an “unrelated party.” The term “qualified verifier” means any individual or organization with active accreditation (i) as a validation and verification body from the American National Standards Institute National Accreditation Board, or (ii) as a verifier, lead verifier, or verification body under the California Air Resources Board Low Carbon Fuel Standard program. The Treasury Department and the IRS are requesting comments as to the definition of “qualified verifier,” including whether additional accreditations that demonstrate sufficient expertise for verification of lifecycle analysis for the §45V credit should be included.

4. Election to Treat Clean Hydrogen Production Facility as §48 Energy Property

Procedures; Irrevocable Election; Availability of Election. The proposed regulations set forth detailed rules regarding the time and manner of making the election, including rules applicable to Partnerships and S Corporations and reiterate that the election to treat a clean hydrogen production facility as energy property is irrevocable. The election is available for property placed in service after December 31, 2022, and, for any property that began construction before January 1, 2023, only to the extent of the basis thereof attributable to the construction, reconstruction, or erection after December 31, 2022.

Credit Recapture – Emissions Tier Recapture Event. The proposed regulations provide that if an “emissions tier recapture event” occurs, the tax imposed on the taxpayer for that year is increased by a specified recapture amount. An emissions tier recapture event can occur if the taxpayer fails to obtain an annual verification report by the deadline for filing its Federal income tax return or information return (including extensions) for any taxable year in which an annual verification report was required if the hydrogen production results in a lower energy percentage than used to calculate the credit, or if the GHG emissions rate exceeds 4 kilograms of CO2e per kilogram of hydrogen. See Emissions Tiers 1, 2, 3 or 4. The 5-year recapture period would begin on the first day 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.

Recapture Amount. The recapture amount for the taxable year in which the emissions tier recapture event occurred is equal to 20% of the excess of the ITC allowed for the facility over the credit that would have been allowed if the actual production was used.

5. RNG and Fugitive Sources of Methane

The Treasury Department and the IRS intend to provide rules addressing sources of methane (for example, from coal mine operations) for purposes of the §45V credit.  The Treasury and the IRS anticipate requiring that for purposes of the §45V credit, biogas or biogas-based RNG receive a low emissions value consistent with that gas (and not standard natural gas). It is further anticipated that the RNG used during the hydrogen production process must originate from the first productive use of the relevant methane (i.e., the time when a producer of that gas first begins using or selling it for productive use in the same taxable year as (or after) the relevant hydrogen production facility was placed in service). The Treasury Department and IRS are seeking comments as to a number of questions regarding RNG and fugitive methane sources, including monitoring, reporting, and verification processes and greenhouse gas emissions associated with production, transportation and disposal systems and applicable markets.

6. Coordination with §45Q

The proposed regulations provide that qualified clean hydrogen produced at a qualified clean hydrogen production facility that includes carbon capture equipment for which a credit is allowed to any taxpayer under IRC §45Q for the taxable year or any prior taxable year, no §45V credit is allowed. However, the proposed regulations provide that if the 80/20 Rule provided in §1.45Q-2(g)(5) is satisfied with respect to such carbon capture equipment [i.e., the FMV of used equipment is not greater than 20% of the total value], and no new §45Q credit has been allowed to any taxpayer for such carbon capture equipment, then the unit of carbon capture equipment for which the 80/20 rule is satisfied will not be treated as carbon capture equipment for which a §45Q credit was allowed to any taxpayer for any prior taxable year.

Key Takeaways

The PTC under IRC §45V and the ITC under IRC §48, as amended by the IRA, represent two important incentives intended to accelerate the growth of the hydrogen industry.  With that in mind, the hydrogen industry urged the Treasury Department and IRS to avoid making the rules inflexible and overly restrictive.  It seems likely that many within the hydrogen industry will question various limitations within the proposed regulations, as supplemented by the DOE Guidance.  In addition, as indicated above, there are open questions for which the IRS and Treasury are seeking comments. That said, it is reasonable to expect that significant comments will be submitted as interested parties attempt to further shape the regulations before they go final.

The attorneys at Buchanan Ingersoll & Rooney PC are uniquely positioned to assist clients, including investors and/or developers of hydrogen projects, in examining these detailed, but impactful, rules, as well as assisting with the preparation and submission of comments.