The full cost of the $7,500 electric vehicle tax credit can be hard to get
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The historic climate bill signed into law by President Joe Biden in August offered federal tax credits of up to $7,500 for households that buy new electric vehicles.
But it can be difficult for consumers to get the full value of the tax credit — at least initially.
This is largely due to the structure of the clean car loan and certain requirements for consumers and automakers. However, in the long term, these obstacles may disappear, experts say.
The “bummer” of the tax credit: it is non-refundable
The law, called the Inflation Reduction Act, made the tax credit “non-refundable”.
This means that consumers can only receive the full financial benefit if they incur a federal tax liability of at least $7,500. The non-refundable credit offsets the consumer’s federal tax bill, but any remaining value is lost.
Let’s say a consumer buys an electric car today. When filing a 2022 tax return, a person discovers they owe $5,000 in federal taxes. This person will not receive the full $7,500 tax credit – they will be able to claim $5,000 and reduce their tax bill to zero. But the remaining $2,500 will be lost. In other words, these funds will not be issued to the consumer as a tax refund.
Also, unlike some of the other tax credits in the bill, such as Clean home energy credit for home solar panels and other installations – any unused value is not carried forward to future tax years to offset future tax bills.
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“It’s kind of a bummer” of credit, said Dan Herron, a certified public accountant and certified financial planner in San Luis Obispo, California.
Consumers with high incomes tend to be the most likely to benefit from the full cost of credit compared to those with more modest incomes, Herron said, because they tend to have larger tax bills. But the loan comes with some additional restrictions, such as a marginal income, described in more detail below, which limits how many of those households can benefit.
Meanwhile, middle- and low-income shoppers typically have smaller tax bills, meaning they’re more likely to not get full credit, Herron said.
States, municipalities, and utilities may also offer financial incentive to buy electric vehicles.
How to deal with tax deduction
Consumers who want to buy an electric car and think their tax bills will be too small to get the full $7,500 can take steps to increase their tax liability and therefore maximize the cost of credit.
For example, investors may consider converting a pre-tax retirement account to a Roth after-tax account; they will pay income tax on that conversion. Investors may also consider selling winning shares or other assets, which will result in the payment of capital gains tax.
“If you can make some profit or have some extra income, you can make a profit in 2022, maybe you will consider it,” Herron said.
Employees can also adjust withholding tax from their paychecks by opting to withhold less and thereby increase their taxes.
However, Herron does not recommend this route due to potential obscurity. For example, an unexpected premium during the year could mean a larger-than-expected annual tax bill, depending on the withholding adjustment.
Options that can reduce credit
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In addition to the tax credit structure, the Inflation Reduction Act sets requirements for the new green vehicles themselves, which may limit the amount of your tax credit.
As of Aug. 16, when Biden signed the Inflation Reduction Act, the car’s final assembly must be done in North America to qualify for tax credits. The US Department of Energy has list vehicles that meet this standard.
Additional rules come into force in 2023.
First, there are income restrictions. The tax credit is not available to single persons with modified adjusted gross income in the amount of 150,000 US dollars. The ceiling is higher for others – $225,000 for heads of household and $300,000 for married couples who file a joint tax return. (The test is applied to income for the current or previous year, whichever is less.)
And some cars may not qualify due to the price. Sedans with a retail price over $55,000 are not eligible, and vans, SUVs, or trucks over $80,000.
There are many uncertainties.
Joel Levin
CEO of Plug In America
Two other rules apply to manufacturing: one contains requirements for sources of essential minerals for automotive batteries; the second requires that some of the battery components be manufactured and assembled in North America. Consumers lose half the value of the tax credit—up to $3,750—if one of these requirements is not met; they will lose the full $7,500 for not meeting both conditions.
It is not yet clear which electric vehicles will meet these standards and qualify for the tax credit next year. There’s a chance no one can qualify right away, according at the Automotive Innovation Alliance.
“There is a lot of uncertainty,” said Joel Levin, chief executive of Plug In America.
“If you need a car, I think it’s risky to put off buying in the hope of getting a loan,” he added. “It might not work, or it might be a couple of years before it’s eligible.”
As another consideration, consumers who buy Tesla or General Motors models before tougher rules go into effect on January 1 are not eligible for tax credits based on earlier sales cap settings that expire at the end of the year.
There is another option: buy a used electric car instead of a new one.
The Inflation Reduction Act created a “previously owned clean car loan” of up to $4,000 starting in 2023. The tax credits have some limits (such as a $25,000 cap on the price of a car and lower income limits for consumers) but do not meet requirements for new car production and assembly.
A more user-friendly option
Consumers who are willing to wait until 2024 to buy a new or used car and receive the associated tax breaks will have the most consumer-friendly option at their disposal, experts say.
That’s because the climate law would allow the buyer to pass on their tax credit to the car seller. The dealer, which must register with the US Treasury Department, will receive an upfront payment in the form of a consumer tax credit from the federal government.
As a result, consumers are likely to receive a full point-of-sale tax credit from the car dealer in the form of a discount on the list price or a reduction in the car’s down payment, Levin said. And they will receive this rebate even if they have no tax liability, he added.
“This makes credit much more valuable to people, especially middle-income people who don’t have a lot of money in their pockets for a down payment,” Levine said.
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