Tax credits were enacted recently to encourage increased production and use of sustainable aviation fuel (SAF) in lieu of conventional jet fuel, which produces around 3% of the world’s annual carbon emissions. The aviation industry itself has set a goal of reaching net-zero carbon emissions by 2050, and many fuel producers and aviation providers have been embedding environmental, social, and governance (ESG) initiatives into their business strategies, including mechanisms to lower greenhouse gas (GHG) emissions.
Although SAF has lower emissions, industrywide adoption of the fuel is hampered, in part, by higher production costs. To reduce some of those costs and incentivize production, the tax credits described in this item were enacted.
What is sustainable aviation fuel?
SAF is jet fuel derived at least in part from synthetic, renewable, or nonpetroleum sources such as cooking oil, solid waste, and energy crops. In contrast, conventional jet fuel is kerosene derived from petroleum. SAF produces significantly fewer GHG emissions than conventional jet fuel, such that the International Air Transport Association (IATA) estimates widespread use of SAF could contribute around 65% of the needed emissions reductions to reach the 2050 net-zero emissions goal. Ideally, SAF is designed to be compatible with the existing fuel distribution infrastructure and aircraft engines, which removes a potential barrier to adoption.
A government priority
The U.S. government has initiated several programs designed to reduce GHG emissions from conventional transportation fuels. The Environmental Protection Agency’s (EPA’s) Renewable Fuel Standard Program requires a certain volume of domestically produced renewable fuel to replace petroleum-based transportation and jet fuel each year. A multiagency “SAF Grand Challenge” has been tasked with enabling production of 3 billion gallons of SAF per year by 2030. Most recently, the Inflation Reduction Act, P.L. 117-169, added a number of clean fuel incentives to the Internal Revenue Code. New Secs. 40B and 6426(k), which are the focus of this discussion, provide volumetric tax credits to U.S. producers of “SAF qualified mixtures.” Sec. 40B is a nonrefundable general business income tax credit, and Sec. 6426(k) is an excise tax credit that is refundable to the extent it exceeds excise tax liability.
Understanding the SAF federal credit and excise tax implications
The SAF credit is $1.25 per gallon of SAF used to produce an SAF qualified mixture. The SAF qualified mixture must be produced with SAF that is certified to have a life cycle GHG emissions reduction percentage of at least 50%. Any SAF that exceeds the 50% reduction is eligible to earn 1 cent for each additional percentage point of reduction, capped at 50 cents in additional credit per gallon.
The SAF qualified mixture must be produced with “sustainable aviation fuel,” which is defined as the portion of liquid jet fuel that:
The credit is claimed by U.S. producers of SAF qualified mixtures, which can be produced in two ways: (1) by mixing conventional kerosene and an “SAF synthetic blending component” (liquid fuel that meets the specifications of one of the ASTM D7566 Annexes); or (2) by co-processing petroleum with synthesized hydrocarbons derived from synthesis gas via the Fischer-Tropsch process under ASTM D1655 Annex A1 (SAF co-processed qualified mixture). (The latter type is not currently produced in the United States.) The resulting SAF qualified mixture must qualify as jet fuel. The qualified mixture must be sold for use or used in an aircraft by the claimant in the course of its business and be transferred into the fuel tank of an aircraft in the United States.
Producers and importers of SAF must be registered by the IRS under Sec. 4101. Any SAF blending component that is sold or used as fuel is subject to an excise tax under Sec. 4041 in certain cases. SAF qualified mixtures are taxed as kerosene under Sec. 4081. Additionally, the mixture producer, which may not be the same person as the SAF producer, is required to be registered by the IRS (Sec. 4101).
Registrations and claim requirements for the credit
In addition to the rules and definitions found in the Code, the IRS released Notice 2023-6 to provide additional guidance relating to registrations, certificates, and claim requirements. The notice specifies that the person eligible to claim the SAF credit is the person who produces the SAF qualified mixture, which does not have to be the same person who produced or imported the SAF synthetic blending component. Both parties, however, are required to be registered.
Registrations: The notice clarifies that the producer or importer of an SAF blending component, the U.S. producer of an SAF co-processed qualified mixture, or a person likely to become engaged in either business activity must be registered by the IRS. The IRS will not register an importer of a co-processed liquid fuel or an importer of an SAF qualified mixture because the production must occur in the United States to qualify. Application for registration is made on Form 637, Application for Registration (For Certain Excise Tax Activities), using Activity Letter SA. The application must include detailed business information required in the form, as well as:
The notice provides a safe harbor for complying with these certification requirements and links to approved sustainability certification schemes.
Additionally, because SAF qualified mixtures are taxed as kerosene, the notice states that the mixture producer must be registered by the IRS under Activity Letter S (for producers of SAF qualified mixtures within the bulk transfer system) or Activity Letter M (for producers of SAF qualified mixtures outside the bulk transfer system).
Claim requirements for the credit: To claim the SAF incentive, the notice requires specific information and documentation. Each claim relating to an SAF qualified mixture (i.e., not an SAF co-processed qualified mixture) must contain:
Model certificate, declaration, and reseller statements are included as appendices to the notice.
A taxpayer claiming the credit as a nonrefundable general business income tax credit uses Form 8864, Biodiesel, Renewable Diesel, or Sustainable Aviation Fuels Credit. In the alternative, a taxpayer claiming an excise tax credit must first use Form 720, Quarterly Federal Excise Tax Return, to claim a credit against excise tax. Any excess credit may be claimed as an excise tax payment (on Form 720, if reporting fuel excise taxes, or on Form 8849, Schedule 3, Certain Fuel Mixtures and the Alternative Fuel Credit) or as a refundable income tax credit (on Form 4136, Credit for Federal Tax Paid on Fuels). Additional statute-of-limitation and other filing considerations must be met.
State incentives for airlines and producers
In addition to the federal SAF credit available to producers of qualified mixtures, some state legislatures are seeking to incentivize SAF. Illinois is among the first states to enact a specific SAF tax incentive. From June 1, 2023, through Jan. 1, 2033, Illinois law provides a $1.50 per gallon state use tax credit for air carriers that purchase or use SAF in Illinois (35 Ill. Comp. Stat. 105/3-87 (use tax credit); 35 Ill. Comp. Stat. 110/3-72 (service use tax credit)). The credit may be claimed against the state’s use tax, which applies to aviation fuel, and requires certification. Unlike the federal producer credit, the Illinois SAF credit applies later in the supply chain and is available only to the air carrier. In general, Illinois conforms to the federal definition of SAF found in Sec. 40B. However, the state temporarily (until June 1, 2028) allows credits for SAF derived from waste streams or gaseous carbon dioxides. Beginning June 1, 2028, Illinois will limit the credit to SAF derived from domestic biomass resources. In response to concerns over the impact on renewable diesel, another soybean oil–derived fuel, Illinois caps the total SAF credit available for soybean oil– derived SAF once a taxpayer reaches a certain threshold of soybean oil–derived SAF-related credit.
Legislators in Washington state are considering similar credits and incentives for SAF producers and consumers (H.B. 1505 and S.B. 5447). Moreover, California, Oregon, and Washington all have low-carbon fuel standard programs similar to the EPA’s Renewable Fuel Standard Program. These programs present opportunities to both fuel producers and aviation providers that may benefit from producing or consuming low-carbon fuel.
A greener future for air travel
Air transportation providers and consumers are increasingly focused on sustainability. Any fuel producer or airline seeking to enhance its ESG profile through production or use of SAF may be further incentivized by the related tax credits created by the Inflation Reduction Act. The industry benefits not only by obtaining cash incentives but also by demonstrating to consumers a commitment to more sustainable aviation.
The SAF credits come with many documentation and substantiation requirements. SAF producers, their air transportation industry partners, and all parties along the supply and distribution chain must align processes and priorities to check all required boxes and qualify for the relevant credits. For example, the federal SAF credit requires obtaining and exchanging various certificates, statements, and declarations. In addition, the credits require precise tracking of each gallon of SAF and certification of compliance with various sustainability benchmarks. Nonetheless, tax credits focused on sustainability and carbon neutrality present an opportunity for the air transportation industry to take some risks, innovate, and bolster use of alternative and renewable fuels such as SAF.
Editor notes
Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C. Contributors are members of or associated with KPMG LLP. For additional information about these items, contact Van Leuven at 202-533-4750 or mvanleuven@kpmg.com.
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.