Clean fuel production credit: Regulatory roadblocks ahead

Editor: Mary Van Leuven, J.D., LL.M.

The Sec. 45Z clean fuel production credit is a significant initiative introduced by the Inflation Reduction Act of 2022, P.L. 117–169. This credit aims to incentivize the production of clean transportation fuels, including either sustainable aviation fuel (SAF) or non–SAF transportation fuel, within the United States by offering tax credits to producers that meet specific environmental criteria.

To be eligible for the credit in a specific tax year, taxpayers must produce a qualifying transportation fuel within the United States for sale to an unrelated party for certain specified purposes. A non–SAF transportation fuel must be produced in accordance with certain feedstock requirements, must be suitable for use in highway vehicles or aircraft, and must have a lifecycle greenhouse gas (GHG) emissions rate of no more than 50 kilograms per carbon dioxide equivalent (CO2e) (based on relative global warming potential) per million British thermal units (mmBTU) (Secs. 45Z(b)(1)(A) and (d)). Alternatively, SAF must adhere to specific industry standards, meet a separate set of feedstock requirements, and be sold for use in aircraft.

On Jan. 10, 2025, Treasury and the IRS issued Notice 2025–10, which contains draft forthcoming proposed regulations for the Sec. 45Z clean fuel production credit, and Notice 2025–11, which includes the Sec. 45Z annual emissions rate table. Also in January, the Department of Energy released the 45ZCF–GREET model, with a user manual and other information, to calculate emissions for non–SAF transportation fuel. Overall, the guidance provides helpful information but ultimately neglects several crucial industry issues. Therefore, taxpayers in the clean fuel industry are evaluating how to apply the notices, given their nonbinding and somewhat ineffective nature.

This item explores two key issues among many that are puzzling industry participants: imported used cooking oil (UCO) and the definition of a qualifying sale, particularly for clean fuel producers selling to wholesalers. The lack of clarity in these areas could significantly affect the clean fuel industry’s ability to generate the Sec. 45Z credit.

Imported UCO

The forthcoming proposed regulations do not provide specific guidance on the use of imported UCO as a feedstock eligible for the Sec. 45Z credit, specifically with respect to non–SAF transportation fuel. Notice 2025–10 contemplates concerns regarding the identification and market implications of imported UCO, particularly the risk of mislabeling substances such as virgin palm oil as UCO. Compared to palm oil, genuine UCO has a significantly lower GHG emissions rate, meaning that producing biodiesel from UCO generates considerably fewer carbon emissions than producing it from palm oil. This is primarily because UCO is considered a waste product that would otherwise be discarded, while palm oil production is often linked to large–scale deforestation, leading to high GHG emissions. Therefore, this mislabeling could potentially lead to higher emissions impacts than genuine UCO. Due to these concerns, the notice provides that pathways using imported UCO are currently unavailable in the 45ZCF–GREET model until further guidance is issued. When the current 45ZCF–GREET model does not include certain feedstocks such as imported UCO in its production pathways, the taxpayer must request a provisional emissions rate (PER) to establish an official emissions rate for its product.

This guidance fails to provide a specific PER process for taxpayers to follow, which creates significant uncertainty for industry participants that have relied on imported UCO as a sustainable feedstock, and this lack of a defined process will lead to difficulties in ensuring compliance and claiming the Sec. 45Z credit. To complicate this further, there is not an anticipated date for further guidance under the new administration; therefore, taxpayers that use imported UCO will be left searching for answers in the interim, making it difficult to estimate this incentive’s benefits.

Qualifying sale

Next, a contentious issue is the impact of Notice 2025–10’s limiting definition of a “qualifying sale.” Sec. 45Z(a)(4) provides three ways a taxpayer can demonstrate a qualifying sale. One is a sale to an unrelated person “for use by such person in a trade or business” (Sec. 45Z(a)(4)(B)). This statutory language has been interpreted by many industry participants to give a broad application of the term “use” to a purchaser’s business activities, including wholesaling. The initial guidance, however, refines this definition by clarifying that a sale “for use in a trade or business” means “sold for use as a fuel in a trade or business within the meaning of section 162 of the Code” (emphasis added). The introduction of the limiting requirement that the purchaser’s use be exclusively as a fuel within the meaning of Sec. 162 is a clear deviation from the statutory language but appears intentional. The narrowly applied definition provided in the draft text of the forthcoming proposed regulations consequentially appears to exclude sales to wholesalers by clean fuel producers.

This proposed interpretation is significant because wholesalers play a crucial role in the supply chain by purchasing large quantities of fuel from producers and then distributing it to retailers or directly to end users, allowing producers to reach a broader market. This arrangement benefits producers by providing a steady demand for their products and reducing the complexity and costs associated with direct sales and distribution logistics. Hence, the additional language in the forthcoming proposed regulations leaves a gap in understanding whether these transactions qualify for the credit, potentially excluding a significant portion of the market from the benefit of the Sec. 45Z credit. Taxpayers are wondering if Treasury and the IRS intended this result, because the inclusion of a wholesaler in the supply chain would seemingly negate the credit for the producer’s sale of otherwise eligible fuel.

Gaps in the guidance

Overall, taxpayers have several concerns about the notices. While these notices offer some guidance, there is uncertainty about how much of the forthcoming proposed regulations will be finalized and enforceable as drafted in their present form. Most significantly, as outlined above, there are several gaps in the guidance, leaving the industry concerned and unable to adequately plan for how to apply the Sec. 45Z credit.

Editor Notes

Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C.

For additional information about these items, contact Van Leuven at mvanleuven@kpmg.com.

Contributors are members of or associated with KPMG LLP.

The information in these articles is not intended to be “written advice concerning one or more federal tax matters” subject to the requirements of Section 10.37(a)(2) of Treasury Department Circular 230. The information contained in these articles is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. The articles represent the views of the authors only and do not necessarily represent the views or professional advice of KPMG LLP.