Practical advice on current issues.

AuthorVan Leuven, Mary

Credits Against Tax

Sustainable aviation fuel incentives take off

Tax credits were enacted recently to encourage increased production and use of sustainable aviation fuel (SAP) in lieu of conventional jet fuel, which produces around 3% of the world's annual carbon emissions. The aviation industry itself has set a goal of reaching net-zero carbon emissions by 2050, and many fuel producers and aviation providers have been embedding environmental, social, and governance (ESG) initiatives into their business strategies, including mechanisms to lower greenhouse gas (GHG) emissions.

Although SAF has lower emissions, industrywide adoption of the fuel is hampered, in part, bv higher production costs. To reduce some of those costs and incentivize production, the tax credits described in this item were enacted.

What is sustainable aviation fuel?

SAF is jet fuel derived at least in part from synthetic, renewable, or nonpetroleum sources such as cooking oil, solid waste, and energy crops. In contrast, conventional jet fuel is kerosene derived from petroleum. SAF produces significantly fewer GIIG emissions than conventional jet fuel, such that the International Air Transport Association (IATA) estimates widespread use of SAF could contribute around 65% of the needed emissions reductions to reach the 2050 net-zero emissions goal. Ideally, SAF is designed to be compatible with the existing fuel distribution infrastructure and aircraft engines, which removes a potential barrier to adoption.

A government priority

The U.S. government has initiated several programs designed to reduce GHG emissions from conventional transportation fuels. The Environmental Protection Agency's (EPA's) Renewable Fuel Standard Program requires a certain volume of domestically produced renewable fuel to replace petroleum-based transportation and jet fuel each year. A multiagency "SAF Grand Challenge" has been tasked with enabling production of 3 billion gallons of SAF per year by 2030. Most recently, the Inflation Reduction Act, P.L. 117-169, added a number of clean fuel incentives to the Internal Revenue Code. New Sees. 40B and 6426(k), which are the focus of this discussion, provide volumetric tax credits to U.S. producers of "SAF qualified mixtures." Sec. 40B is a nonrefundable general business income tax credit, and Sec. 6426(k) is an excise tax credit that is refundable to the extent it exceeds excise tax liability.

Understanding the SAF federal credit and excise tax implications

The SAF credit is $1.25 per gallon of SAF used to produce an SAF qualified mixture. The SAF qualified mixture must be produced with SAF that is certified to have a life cycle GI IG emissions reduction percentage of at least 50%. Any SAF that exceeds the 50% reduction is eligible to earn 1 cent for each additional percentage point of reduction, capped at 50 cents in additional credit per gallon.

The SAF qualified mixture must be produced with "sustainable aviation fuel," which is defined as the portion of liquid jet fuel that:

* Is not kerosene;

* Meets certain American Society for Testing and Materials (ASTM) specifications under ASTM D7566 Annexes or ASTM D1655 Annex Al (Fischer-Tropsch provisions);

* Is not derived from co-processing monoglycerides, diglycerides, triglycerides, free fatty acids, or tree fatty acid esters (or derivatives thereof) with a nonbiomass feedstock;

* Is not derived from palm fatty acid distillates or petroleum; and

* Is certified as having a life cycle GHG emissions reduction percentage of at least 50%. (The Code requires certification pursuant to the most recent Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) that has been adopted by the International Civil Aviation Organization (ICAO), or any similar methodology that satisfies Section 211(o)(1)(H) of the Clean Air Act.)

The credit is claimed by U.S. producers of SAF qualified mixtures, which can be produced in two ways: (1) by mixing conventional kerosene and an "SAF synthetic blending component" (liquid fuel that meets the specifications of one of the ASTM D7566 Annexes); or (2) by co-processing petroleum with synthesized hydrocarbons derived from synthesis gas via the Fischer-Tropsch process under ASTM D1655 Annex A1 (SAF co-processed qualified mixture). (The latter type is not currently produced in the United States.) The resulting SAF qualified mixture must qualify as jet fuel. The qualified mixture must be sold for use or used in an aircraft by the claimant in the course of its business and be transferred into the fuel tank of an aircraft in the United States.

Producers and importers of SAF must be registered by the IRS under Sec. 4101. Any SAF blending component that is sold or used as fuel is subject to an excise tax under Sec. 4041 in certain cases. SAF qualified mixtures are taxed as kerosene under Sec. 4081. Additionally, the mixture producer, which may not be the same person as the SAF producer, is required to be registered by the IRS (Sec. 4101).

Registrations and claim requirements for the credit

In addition to the rules and definitions found in the Code, the IRS released Notice 2023-6 to provide additional guidance relating to registrations, certificates, and claim requirements. The notice specifies that the person eligible to claim the SAF credit is the person who produces the SAF qualified mixture, which does not have to be the same person who produced or imported the SAF synthetic blending component. Both parties, however, are required to be registered.

Registrations: The notice clarifies that the producer or importer of an SAF blending component, the U.S. producer of an SAF co-processed qualified mixture, or a person likely to become engaged in either business activity must be registered by the IRS. The IRS will not register an importer of a co-processed liquid fuel or an importer of an SAF qualified mixture because the production must occur in the United States to qualify. Application for registration is made on Form 637, Application for Registration (For Certain Excise Tax Activities), using Activity Letter SA. The application must include detailed business information required in the form, as well as:

* A sample Certificate of Analysis (COA) from an unrelated third party;

* Certification of a life cycle GHG emissions reduction percentage of at least 50%; and

* Certification from an unrelated party demonstrating compliance with the general requirements, supply chain traceability requirements, and information transmission requirements established under CORSIA or other similar methodology.

The notice provides a safe harbor for complying with these certification requirements and links to approved sustainability certification schemes.

Additionally, because SAF qualified mixtures are taxed as kerosene, the notice states that the mixture producer must be registered by the IRS under Activity Letter S (for producers of SAF qualified mixtures within the bulk transfer system) or Activity Letter M (for producers of SAF qualified mixtures outside the bulk transfer system).

Claim requirements for the credit: To claim the SAF incentive, the notice requires specific information and documentation. Each claim relating to an SAF qualified mixture (i.e., not an SAF co-processed qualified mixture) must contain:

* An original Certificate for SAF Synthetic Blending Component (provided by the SAF blending component producer or importer);

* If applicable, a Statement of SAF Synthetic Blending Component Reseller; and

* A declaration signed under penalties of perjury, containing the COA reference number for the COA associated with the SAF qualified mixture, as well as the COA reference numbers for the SAF synthetic blending component and the kerosene used in the mixture.

Model certificate, declaration, and reseller statements are included as appendices to the notice.

A taxpayer claiming the credit as a nonrefundable general business income tax credit uses Form 8864, Biodiesel, Renewable Diesel, or Sustainable Aviation Fuels Credit. In the alternative, a taxpayer claiming an excise tax credit must first use Form 720, Quarterly Federal Excise Tax Return, to claim a credit against excise tax. Any excess credit may be claimed as an excise tax payment (on Form 720, if reporting fuel excise taxes, or on Form 8849, Schedule 3, Certain Fuel Mixtures and the Alternative Fuel Credit) or as a refundable income tax credit (on Form 4136, Credit for Federal Tax Paid on Fuels). Additional statute-of-limitation and other filing considerations must be met.

State incentives for airlines and producers

In addition to the federal SAF credit available to producers of qualified mixtures, some state legislatures are seeking to incentivize SAF. Illinois is among the first states to enact a specific SAF tax incentive. From June 1, 2023, through Jan. 1, 2033, Illinois law provides a $1.50 per gallon state use tax credit for air carriers that purchase or use SAF in Illinois (35 Ill. Comp. Stat. 105/3-87 (use tax credit); 35 Ill. Comp. Stat. 110/3-72 (service use tax credit)). The credit may be claimed against the state's use tax, which applies to aviation fuel, and requires certification. Unlike the federal producer credit, the Illinois SAF credit applies later in the supply chain and is available only to the air carrier. In general, Illinois conforms to the federal definition of SAF found in Sec. 40B. However, the state temporarily (until June 1, 2028) allows credits for SAF derived from waste streams or gaseous carbon dioxides. Beginning June 1, 2028, Illinois will limit the credit to SAF derived from domestic biomass resources. In response to concerns over the impact on renewable diesel, another soybean oil-derived fuel, Illinois caps the total SAF credit available for soybean oil-derived SAF once a taxpayer reaches a certain threshold of soybean oil-derived SAF-rclated credit.

Legislators in Washington state are considering similar credits and incentives for SAF producers and...

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