# Prop. Treas. Reg. § 1.40-2: Small ethanol producer credit. Proposed regulation, not in force. REG-155087-05, 73 FR 43890, published 2008-07-29 . Interprets 26 U.S.C. § 40. Par. 3. Sections 1.40-2 and 1.40A-1 are added to read as follows: (a) In general. Section 40 provides a small ethanol producer credit for each gallon of qualified ethanol production of an eligible small ethanol producer. Section 40(b)(4)(B) defines “qualified ethanol production”. Section 40(g)(1) defines “eligible small ethanol producer”. Section 40(g)(5) provides authority to prescribe such regulations as may be necessary to prevent the credit from directly or indirectly benefiting any person with a direct or indirect productive capacity of more than 60 million gallons of alcohol during the taxable year. A person has produced ethanol if the person has title to the ethanol immediately after it is created. (b) Qualified ethanol production. Section 40(b)(4)(B) limits qualified ethanol production to ethanol that is produced by an eligible small ethanol producer. Ethanol is “produced” for this purpose only when a feedstock other than ethanol is transformed into ethanol. (c) Denial of credit for ethanol produced at certain facilities. The person at whose facilities ethanol is produced is treated for purposes of section 40(g)(5) as an indirect beneficiary of any credit allowed with respect to the ethanol. Accordingly, the small ethanol producer credit is not allowed with respect to ethanol that is produced at the facilities of a contract manufacturer or other person if such contract manufacturer or other person has a direct or indirect productive capacity of more than 60 million gallons of alcohol during the taxable year. Similarly, if the manufacturer does not have a productive capacity of more than 60 million gallons but more than 15 million gallons of ethanol is produced at the manufacturer's facilities during the taxable year, the small ethanol producer credit is allowed with respect to only the first 15 million gallons of ethanol produced at the facilities during the taxable year. (d) Examples. The following examples illustrate the application of this section: Example 1. X purchases hydrous ethanol and processes it into anhydrous ethanol. X is not the producer of the ethanol because X does not transform a feedstock other than ethanol into ethanol. Example 2. Y arranges with contract manufacturer Z to produce 10 million gallons of ethanol. Y is not related to Z. Y provides the raw materials and retains title to them and to the finished ethanol. Z has the capacity to produce 100 million gallons of alcohol per year. The small producer credit is not allowed with respect to the 10 million gallons of ethanol because it is produced at the facilities of a contract manufacturer that has a productive capacity of more than 60 million gallons of alcohol during the taxable year. (e) Effective/applicability date. This section is applicable on and after the date of publication of these regulations in the Federal Register as final regulations.