Biomass and Notice 2006-88

By Todd B. Reinstein, Esq., CPA

As concerns for the nation’s energy supply have risen, the Federal government has periodically provided various incentives to encourage the use of renewable energy sources. Under Sec. 45, Congress provided for a renewable production credit for electricity produced by a taxpayer from qualified energy resources (wind, closed- and open-loop biomass, geothermal and solar energy, small irrigation power, municipal solid waste and hydropower) at a qualified facility. Sec. 45(a) provides that the credit for a tax year is 1.5¢ (adjusted for inflation) for each kilowatt hour of electricity produced and sold by the taxpayer from qualified energy resources at a qualified facility for a 10-year period beginning after the facility was placed in service.

Although not as well known as wind- or solar-powered energy sources, electricity generated from biomass facilities is considered one of the largest sources of renewable energy in the U.S. Biomass is the conversion of plant matter into electricity by incinerating the natural waste products from such matter. Open-loop biomass was added to the definition of qualified energy resources, and open-loop biomass facilities were added to the definition of qualified facilities, in Sec. 45 by the American Jobs Creation Act of 2004, Section 710.

On Sept. 26, 2006, the IRS issued Notice 2006-88 to address a number of open issues on the application of Sec. 45 to open-loop biomass facilities. The notice includes much-needed guidance on key issues, such as co-firing, netting of electric output and placed-in-service dates.


A major area of concern for taxpayers is how to treat open-loop biomass plants that co-fire qualifying biomass material and qualifying material. The profitability of an energy facility is generally related to the amount of heat embedded in the incinerated material. Biomass sources produce less heat than conventional fossil fuels; thus, many biomass facilities need to add non-biomass materials that generate more heat to raise the temperature of the incineration. 

Prior to Notice 2006-88, it was unclear whether a facility that co-fired other material would still qualify for the credit. The notice clarifies that electricity produced from open-loop biomass, co-fired with fuels other than fossil fuels, may qualify separately for the credit (fossil fuels may, however, be used as part of the start-up or flame stabilization process). If a taxpayer produces and sells electricity from both open-loop biomass and other nonqualifying fuels, the credit will be determined based on the thermal content of the open-loop biomass as compared to the thermal content of all fuels. When two or more fuels are co-fired to produce electricity, the “applicable percentage” of electricity sold to third parties is the amount eligible for the credit.


To qualify for the Sec. 45 credit, the electricity generated from renewable sources must be sold to an unrelated third party. The notice interpreted this requirement by providing that a taxpayer only receive the credit based on its net electricity output sold to unrelated third parties. Many facilities (particularly paper mills) use the renewable energy produced in a biomass facility as an energy source, in addition to selling the electrical output to unrelated third parties. These facilities often buy and sell electricity from and to utilities based on both parties’ needs. Notice 2006-88 requires that when electricity produced from open-loop biomass at any location is sold by a taxpayer to an unrelated person, and when either the taxpayer or a related person simultaneously purchases electricity from an unrelated person for use at the same location, the sale of the electricity will be treated as a sale to an unrelated person only to the extent that the electricity sold exceeds that purchased. Thus, the credit available to qualified facilities may be limited.

Period in Service

The date a qualified facility is placed in service is critical in determining facility qualification and credit period. The credit period for a qualifying open-loop biomass facility depends on when the facility was placed in service: (1) after Aug. 8, 2005, the credit period is 10 years from the placed-in-service date; (2) between Oct. 21, 2004 and Aug. 8, 2005, the credit period is five years from the placed-in-service date; (3) before Oct. 22, 2004, the credit period is five years, beginning Jan. 1, 2005. Notice 2006-88 also provides that, if the open-loop biomass facility is an addition or improvement to an existing facility, it will not be deemed to be placed in service after Oct. 22, 2004 if more than 20% of the facility’s total value is attributable to property placed in service on or before that date.

No-Rulings Area

Notice 2006-88 is considered to be interim guidance, issued pending a formal rulemaking project. It states that the Service will neither issue letter rulings under Sec. 45 with respect to open-loop biomass nor rule under the partnership rules for partnerships claiming the credit. The no-ruling position for Sec. 45 open-loop biomass facilities remains in effect.

As interest in renewable energy sources rises, taxpayers seeking to develop, operate and invest in qualifying projects may be left in the dark, as the IRS is unwilling to provide letter rulings in this new area. As a result, taxpayers developing qualifying projects may seek advice from counsel to develop a position that they will qualify for this new credit.

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