Biofuel Tax Credit Claims Need More Scrutiny, Watchdog Says

April 30, 2024

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by Erin Schilling (Bloomberg Tax) The IRS needs more authority to properly evaluate—and deny, if necessary—biofuel tax credit claims, an agency watchdog said in a new report.

The Treasury Inspector General for Tax Administration evaluated biofuel tax claims and found 42 of the 142 taxpayers sampled didn’t provide the required documentation. That amounted to more than $30.3 million in unallowable biofuel tax credits.

But under current law the IRS can only address the claims after the returns are filed. TIGTA recommended that the IRS work with the Treasury Department’s Office of Tax Policy for a legislative proposal to change that rule. READ MORE

Additional Actions Need to Be Taken to Identify and Address Noncompliant Biofuel Tax Credit Claims (Treasury Inspector General for Tax Administration)
IRS Botching Noncompliant Biofuel Credit Claims, TIGTA Says (Law360)
A Case Study in Tax Credit Fraud and Manipulation, Biofuel Edition (Cato Institute)
IRS Sees Possible Biofuel Credit Fraud: IRS Audit Finds Potential Fraud in Claims for Biofuel Tax Credits (DTN Progressive Farmer)

Excerpt from Treasury Inspector General for Tax Administration: Internal Revenue Code Section 4101 requires applicable taxpayers to register with the IRS before producing or importing biofuels. Additionally, certain taxpayers claiming biodiesel-related tax credits are not required to be registered but must provide a Certificate of Biodiesel from the producer showing that the biodiesel used to produce the mixture met the Environmental Protection Agency’s (EPA) biodiesel specification and registration requirements.

TIGTA analysis found that 42 of 124 taxpayers sampled, that claimed biofuel tax credits totaling about $30.3 million, did not provide either an approved registration number or a Certificate of Biodiesel; therefore, these claims would not be allowable.

Under current law, the IRS could only address these claims after the returns are filed and examined and it issues notices of deficiency to the taxpayers, as appropriate. The IRS does not have the legal authority to deny biofuel tax credits or otherwise enforce the registration requirements on taxpayers who are not eligible to receive the credits at the time a tax return is filed.

TIGTA found that the IRS’s compliance efforts are primarily focused on biofuel tax credit claims made on the Form 8849, Schedule 3, Certain Fuel Mixtures and the Alternative Fuel Credit, and Form 720, Schedule C, Claims, and more effective efforts could be undertaken to evaluate claims made on the Form 4136, Credit for Federal Tax Paid on Fuels.

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I.R.C. § 6426(a) and (c) allows a $1.00 per gallon credit against a taxpayer’s excise tax liability on taxable fuel under I.R.C. § 4081 for blended biodiesel, renewable diesel, and agri-biodiesel. The taxpayers that typically pay excise taxes are those blenders of biodiesel that purchased the diesel to create the qualifying biodiesel mixtures.

Pursuant to I.R.C. § 6427(e), a payment is allowable to the blender of the mixture to the extent the tax credits exceed the blender’s excise tax liability under I.R.C. § 4081. Under I.R.C. § 34, the biodiesel mixture credit described in I.R.C. § 6426 exceeds a person’s I.R.C. § 4081 liability for the quarter of a tax year, an income tax credit is allowable to the producer of the mixture.8

I.R.C. § 40A provides a nonrefundable credit for:

• A biodiesel mixture tax credit for the production of a qualified biodiesel mixture sold for use as a fuel or used as a fuel in the taxpayer’s trade or business.

• A biodiesel tax credit used by the taxpayer in a trade or business or sold by the taxpayer for fuel in a buyer’s vehicle.9

The biodiesel tax credit for any tax year is $1.00 for each gallon of biodiesel or qualified biodiesel mixture.

Alternative fuel credit

Alternative fuels include liquefied petroleum gas, compressed or liquefied natural gas, compressed or liquefied gas derived from biomass, and liquid fuel derived from biomass.10 I.R.C. § 6426(d) provides an alternative fuel credit of $0.50 for each gallon of alternative fuel or gasoline gallon equivalents of a nonliquid alternative fuel sold by the taxpayer for use as a fuel in a motor vehicle or motorboat. Like biodiesel and agri-biodiesel mixtures, any excess over the tax liability may be claimed as a payment under I.R.C. § 6427(e) or under I.R.C. § 34. READ MORE

Excerpt from Cato Institute: In a brazen account of tax fraud, the operators of Washakie Renewable Energy were sentenced to prison in 2023 for a staggering $1 billion biofuel tax credit conspiracy. Over six years, the Internal Revenue Service (IRS) paid out $511 billion in fraudulent tax credits and stopped hundreds of billions more in what the TIGTA report calls “one of the largest fraud schemes in US history.” In reporting on the Washakie case, Bloomberg noted that “by 2017 more than 30 people had been accused of defrauding the IRS in biodiesel tax credit scams.”

In another case, a Colorado man was found guilty of claiming $7 million of biodiesel tax credits for renewable fuel that was never produced. Another story chronicles multiple indictments “for orchestrating a $100 million scheme involving the sale of biofuels and fraudulent claims that the fuels were eligible for tax credits.”

Indicative of poor enforcement and difficult administrability, TIGTA found that one‐third of audited taxpayers’ biofuel credits should have been denied due to a lack of appropriate documentation of eligibility. Insufficient documentation accounted for about 12 percent of the dollar value of the credits claimed in the audited sample.

The biofuel credits are also susceptible to legal exploitation. In one case, an unintentional loophole increased the cost of the subsidy program more than 12 times.

Poorly defined terms in the $0.50 alternative fuels credit allowed enterprising oil industry lawyers to claim credits for their normally produced gasoline. Doug Sword explains that because butane qualified as an alternative fuel, “refiners had a legitimate claim on the credits since they typically mix butane, an easily liquefied natural gas, into gasoline to reduce emissions and help engines run smoother in cold weather.”

When government scorekeepers incorporated the butane tax loophole into their estimates, the cost of the alternative fuels subsidy jumped from $555 million to $7.1 billion for a one‐year extension. Had oil companies been able to claim these credits retroactively, taxpayers could have been on the hook for an additional $50 billion. As part of a year‐end spending package in 2019, Congress clarified the law and made the change retroactive, denying the credit to butane‐mixed gasoline.

No End in Sight

The TIGTA report concludes that “with the passage of additional and expanded clean energy tax credits in the IRA, there is even greater incentive to take advantage of biofuel tax credits and make fraudulent claims for biofuel that does not exist or does not qualify for the biofuel tax credits.”

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The IRA is estimated to include more than $900 billion in new and expanded energy tax credits over 10 years. Many of the credit programs essentially provide cash subsidies (through tradeable tax credits), often in excess of the cost of producing the energy. For example, a new hydrogen tax credit that one analyst called “the most generous clean hydrogen subsidy in the world” could cover more than 100 percent of the cost of production in some places. Such large subsidies will invariably attract new forms of abuse. In another context, the Department of Energy inspector general has said that the IRA spending and loan programs will create an “unprecedented” level of risk for fraud and financial mismanagement.

Unlike the butane loophole, when Congress and the IRS worked in concert to prevent the worst abuses, the Biden administration has been actively expanding loopholes to increase IRA tax credit eligibility and program costs. For example, under a broad interpretation of electric vehicle subsidies, the credits for leased cars are not subject to Congress’s intended restrictions that apply to consumer‐purchased car battery component sourcing, household incomes, and vehicle prices.

With hundreds of billions—if not trillions—of dollars of technologically and administratively complex tax credits up for grabs, Congress should expect history to repeat itself. Pioneering lawyers will find ways to exploit the rules legally, and less scrupulous actors will use the programs’ complexities to defraud taxpayers.

Every energy tax credit should be repealed. They are economically destructive, have proven enforcement problems, and create unexpected financial risks to federal budgets. READ MORE