Taxing Tangle: U.S. IRS Releases Guidance for Clean Hydrogen Production Tax Credit

The U.S. Internal Revenue Service ("IRS") has released proposed regulations regarding the Clean Hydrogen Production Tax Credit introduced in the Inflation Reduction Act of 2022 ("IRA"). The proposed regulations provide more guidance and requirements for producers seeking to benefit from this complex tax credit. The credit, which is codified in Section 45V of the Internal Revenue Code, is designed to offset the costs of production for clean hydrogen—hydrogen that is produced through a process that results in a life-cycle greenhouse gas ("GHG") emissions rate of not greater than four kilograms of carbon dioxide equivalent, or CO2e, per kilogram of hydrogen—at qualified facilities within the United States. This credit is a part of the larger effort to reduce the cost of clean hydrogen, which is an expensive form of clean energy, and make the production of clean hydrogen more economical. 

IRA Provisions

Section 45V establishes the general requirements for clean hydrogen to qualify for the new tax credit. The amount of the credit depends on the rate of emissions in the hydrogen production process. Depending on the life-cycle GHG emissions rate, the credit can be as high as $3.00 or as low as $0.60 per kilogram of qualified clean hydrogen (adjusted for inflation). The owner of a qualified facility that produces qualified clean hydrogen can generally claim the Section 45V credit for the first 10 years after the facility is originally placed in service. To qualify, the clean hydrogen must be produced in the ordinary course of a trade or business of the taxpayer. A third party must provide independent verification of the clean hydrogen's production and subsequent sale or use. The production facility must be located within the United States, and construction of the facility must begin before January 1, 2033. The credit is also subject to prevailing wage and apprenticeship requirements, which, if not satisfied, cause the amount of the otherwise-available credit to be reduced by 80%.

Ultimately, this tax credit is meant to support the Biden administration's goal of reducing the cost of clean hydrogen to $1 per kilogram. This is a significant and ambitious reduction target, as the current cost to produce clean hydrogen is around $5 per kilogram, creating a barrier to the widespread production and use as a deployable form of clean energy. 

Proposed IRS Regulations

In December 2023, the Department of Treasury and the IRS released proposed regulations to clarify and supplement the statutory requirements. The proposed regulations are not yet finalized. 

Computing Life-Cycle GHG Emissions. The proposed regulations address the methodology for computing the life-cycle GHG emissions rate for qualified hydrogen production facilities. For this purpose, "life-cycle" emissions only include emissions through the point of production. In other words, the life cycle is defined based on what is known as a "well-to-gate" boundary, which includes emissions associated with feedstock growth, gathering, extraction, processing, and delivery to a hydrogen production facility. The life-cycle GHG emissions rate is a key metric for hydrogen producers to consider. Depending on the emissions rate, the tax credit's value can fluctuate by up to a factor of five, or the credit may even be lost entirely if emissions exceed the four-kilogram threshold. 

To calculate the life-cycle GHG emissions rate, proposed regulations would generally require taxpayers to use a special version of the Greenhouse Gases, Regulated Emissions, and Energy Use in Transportation model (commonly referred to as the "GREET model") developed by the Argonne National Laboratory. Specifically, they must use the 45VH2-GREET model. The model analyzes certain data inputs to determine the carbon intensity of a given hydrogen production pathway. The required inputs can be extensive, and they vary based on the type of hydrogen production technology or feedstock. Further, the 45VH2-GREET model currently contains certain fixed assumptions, such as upstream methane loss rate, which cannot be modified by users under current guidance. These fixed values or formulas cannot be changed, even if it means that the model would overestimate the emissions rate. Affected taxpayers should closely monitor updates to the 45VH2-GREET model that may occur each year in order to identify changes that may affect the emissions rate from their hydrogen production facilities and, therefore, the size of their tax credit.

The 45VH2-GREET model is only capable of calculating the emissions rate for specific types of hydrogen production pathways. Currently, the model covers eight common pathways, including low-temperature and high-temperature water electrolysis, steam methane reforming of natural gas or landfill gas, autothermal reforming of natural gas or landfill gas, and coal or biomass gasification. However, other production pathways exist that are not yet covered.

In order to claim the Section 45V credit for a hydrogen production pathway that is not included in the applicable GREET model, the proposed regulations require producers to petition the IRS for a provisional emissions rate ("PER"). To obtain a PER, the taxpayer must request an emissions value from the Department of Energy ("DOE") based on a preliminary analysis. The taxpayer's preliminary analysis must generally apply 45VH2-GREET conventions and principles. An applicant seeking to receive an emissions value from the DOE must first complete a front-end engineering and design, or FEED, study, or obtain a similar indication of project maturity, such as a project specification and cost estimation sufficient to inform a final investment decision. On April 11, 2024, Treasury and the IRS announced that the DOE will publish on its website instructions for submitting an emissions value request application, but so far, DOE has not done so. After a taxpayer obtains the DOE-approved emissions value, the taxpayer must file a PER petition with the IRS. The petition must be filed with the taxpayer's federal income tax return for the first year in which the taxpayer intends to rely on the PER process to claim the Section 45V credit for a qualified clean hydrogen production facility.

The "Three Pillars." The proposed regulations also introduced a major set of restrictions on electricity sources used to produce qualified clean hydrogen. These restrictions are commonly known as the "Three Pillars." 

In order for the life-cycle GHG calculation to be reduced for using clean sources of electricity during hydrogen production, the proposed regulations would require taxpayers to purchase and retire qualifying energy attribute certificates ("EACs") that satisfy each of the Three Pillars: (i) incrementality (or additionality); (ii) temporal matching; and (iii) deliverability (or geographical matching). "Incrementality" would generally require the use of electricity produced at a facility that began (or, in certain cases, expanded) commercial production of electricity no more than 36 months before the hydrogen production facility was placed in service. "Temporal matching" would require annual matching of electricity usage for clean hydrogen production to clean electricity generation through January 1, 2028, and, thereafter, would require hourly matching, which is far more challenging from a commercial and technological standpoint. Finally, "deliverability" requirements would demand that the electricity represented by an EAC be generated in the same region of the electric grid as the hydrogen production facility. 

Taxpayers who do not rely on qualifying EACs will be treated as using electricity from the regional electric grid, which will cause most hydrogen producers to exceed the four-kilogram limit on carbon emissions. Thus, compliance with the Three Pillars would frequently be mandatory in order for taxpayers to qualify for the Section 45V credit. Regulators justify the imposition of the Three Pillars as a means of counteracting the additional electricity emissions that hydrogen production would induce. Industry players, on the other hand, have expressed concern that the added costs imposed by the Three Pillars will be a major barrier to the development of the hydrogen market and will disadvantage clean hydrogen compared to other green technologies.

Section 45V and the proposed regulations present many compliance challenges for hydrogen producers. Affected taxpayers should carefully monitor future IRS and DOE guidance, which will continue to be released in the coming years and months. Jones Day professionals frequently assist clients in navigating the requirements of Section 45V. 

— Sean E. Jackowitz (+1.617.449.6936, sjackowitz@jonesday.com) 

— Kelly Rubin (+1.214.969.3768, krubin@jonesday.com)

— Charles T. Wehland (+1.312.269.4388, ctwehland@jonesday.com)

— Jetta Cook (+1.415.875.5769, jettacook@jonesday.com)