Are Carbon Credits Tax Deductible for Businesses?

Carbon Credits Tax Deductible

Carbon credit exchanges are the platforms where companies and individuals purchase credits that reduce emissions on their behalf. The credits are backed by projects that aim to mitigate the effects of climate change, and they can be traded in the voluntary or regulatory markets. Purchasing these credits is an increasingly popular way to combine business savvy with environmental activism.

The tax status of carbon credit exchange is complicated. They can be a tax deduction or a credit. Tax deductions lower your income before calculating your taxes, while tax credits reduce the amount you owe after calculating your taxes. In either case, the benefits of carbon credits can be substantial for your bottom line and your environmental impact.

Voluntary carbon offsets (VCOs) are the credits that can be purchased from organizations whose projects reduce greenhouse gas emissions. VCOs can be purchased through various carbon trading programs, including the American Carbon Registry, the Verified Carbon Standard, and the Chicago Climate Exchange.

Are Carbon Credits Tax Deductible for Businesses?

These types of projects are usually regulated by governments and other governing bodies. For example, the carbon market in China is regulated by the National Development and Reform Commission, which oversees the development of carbon dioxide emission trading rules. There are also carbon credit exchanges in Australia, Canada, and the UK. Buying Australian carbon credit units (ACCUs) is typically tax deductible, while purchasing them in other countries may not be.

There are two main types of carbon credit projects: removal and sequestration. Removal projects seek to decrease the levels of CO2 that are already in the atmosphere by reducing emissions or removing them from the air through methods such as planting trees. Sequestration projects capture and store carbon in the ground, such as through the conversion of coal into natural gas or the reforestation of old-growth forests.

Both of these types of projects can be tax deductible depending on the circumstances and how they are structured. In general, a company would want to make sure that the project is set up in accordance with Section 45Q of the IRS code in order to qualify for tax benefits.

Section 45Q provides that the costs of capturing, utilizing, or disposing of carbon oxide are deductible as an ordinary and necessary expense. For this reason, it is generally beneficial to have legal counsel involved in the planning and execution of a Section 45Q project.

The tax treatment of Section 45Q credits can change if the Internal Revenue Service or other parties issue new rulings or legislation. For this reason, it is important to stay up-to-date on the latest developments in carbon credit tax law.

As regulators and other stakeholders continue to emphasize sustainability, companies must carefully consider the motivation for incurring ESG expenditures. In particular, these expenditures need to be “ordinary and necessary” in the context of the business. This is one of the key factors that the IRS examines when reviewing a company’s return for prior years.