Are Carbon Credit Exchanges Tax Deductible?

Carbon Credit Exchanges Tax Deductible

The carbon marketplace has two significant, separate segments. The regulated market is governed by “cap-and-trade” regulations at the regional and state levels, while the voluntary market serves the interests of businesses (and individuals) that want to show that they’re environmentally conscious or simply want to offset their own emissions.

The purchase of carbon credit exchange to offset one’s own greenhouse gasses is becoming a regular expense for many businesses and individuals. These purchases can be a one-time solution to offset air travel or a monthly solution to balance the carbon footprint from business operations. They also offer an opportunity to generate some additional income. But are these expenses tax deductible? This answer isn’t clear cut and depends on the context of the transactions and the motivations and purposes behind them.

A growing number of companies are incorporating carbon reduction goals into their corporate social responsibility and environmental, social, and governance (ESG) goals. For some, this includes a commitment to zero emissions. The business context of these commitments and goals will influence whether the purchase of VCOs is deductible under IRC Sec. 162.

Are Carbon Credit Exchanges Tax Deductible?

For companies operating in a regulated carbon market, the commitment to zero emissions may be a requirement of the cap-and-trade program they’re participating in. If their emissions exceed the limits set by regulators, they must buy carbon credits in the regulated market to stay below those limits. This provides an incentive to invest in technologies that reduce their overall emission rates.

But in the absence of a regulated market, reducing emissions can be difficult for companies that don’t have a mandate to do so. This is why the voluntary carbon market has developed. The purchasing of VCOs can allow companies to demonstrate their commitment to the environment, and this is an important factor for many companies.

Both the regulated and the voluntary carbon markets are developing rapidly. This is in part due to the emergence of technology that allows for the capture and storage of carbon in the ground, as well as the increased interest from private investors in supporting such projects.

The initial granting of a carbon credit is akin to the granting of an easement, which means that its terms will have a major impact on how it’s treated for income tax purposes. For example, the term of a carbon offset agreement may be shorter than that of a conservation easement and therefore treatable as rent instead of a capital transaction. This could have a significant impact on the ability to sell carbon credits. For this reason, it’s important to get professional tax help when making any carbon credit sales.