Carbon Credits Tax Deductible
A carbon offset is an agreement to reduce the carbon footprint of a project or activity. It can be purchased by individuals as a way of doing their part to fight climate change, and it may also be used by businesses to help meet sustainability goals. The question of whether carbon credits are tax deductible depends on how they are classified for legal purposes and their relationship to the person or business purchasing them. A tax professional can assist with determining whether an individual or business’ purchase of carbon.credit is a taxable transaction.
A credit is an item of value that a person or business receives in exchange for performing a service. There are several types of carbon credits, each with a different level of emission reductions associated with them. One of the most common types of carbon credits is called a Certified Emission Reduction (CER) Credit, which is created by companies that perform verified emissions reduction activities. CER credits can be sold to other companies that need them to reach their emission reduction targets, and they are typically traded on the open market with prices fluctuating based on supply and demand.
Other carbon credits are created through activities that capture and store carbon in the long term, such as by planting trees or using geological storage methods. Some of these projects are funded by for-profit entities, while others are funded by nonprofit organizations. The IRS does not consider purchases of carbon offsets from for-profit companies to be a deductible expense, but it does allow individuals to deduct donations made to eligible nonprofit organizations.
Are Carbon Credits Tax Deductible?
To be considered a charitable contribution, a carbon offset must be purchased from a qualified organization that is a 501(c)3 corporation. A tax professional can help determine if an individual or business has met the requirements for a charitable donation to a carbon credit-generating non-profit organization.
If a business purchases VCOs as part of its sustainability efforts, it may be able to deduct them under Section 162(a) of the Internal Revenue Code. However, it will need to be able to show that the purchase of VCOs is primarily for business purposes and not for any other purpose.
Some carbon credits are created by contracts, rather than through sequestration activities. If the contracts are structured correctly, they could be treated as like-kind exchanges under Section 1031 of the Internal Revenue Code. In addition, if the carbon credits are created through activities that involve the use of real property, the contracts could potentially qualify for treatment under Section 45Q. The IRS has not yet issued any guidance on the treatment of 45Q carbon offsets, but if previous guidance related to sulfur emissions allowances is followed, the IRS would consider the VCOs to be capital assets for tax purposes. Tax professionals can advise businesses on how to structure their transactions to take advantage of these potential tax benefits.