Understanding the New Tax Laws for Renewable Energy

The Inflation Reduction Act was signed by President Biden on August 16, 2022, officially making it a law. Although there are numerous aspects to the law, the main provisions that are likely to directly affect our clients are:

  1. A reduction in prices for certain drugs with Medicare plans (although not any time soon!)
  2. Affordable Care Act subsidies continuing through at least 2025
  3. Changes to energy-related tax credits (mostly for electric vehicles, solar panels, and residential energy-efficient improvements)

It’s the third item that is already prompting clients to ask me whether they should buy an electric vehicle now and if they should wait to install solar panels next year. Based on my reading of the available information so far, it’s clear that if a person earns $150k/year as a single, or $300k as a married couple, they should buy the electric vehicle prior to January 1, 2023, in order to benefit from the $7,500 credit still available. In 2022, anyone can buy any electric vehicle for any price and get a $7,500 credit in most cases (Tesla and a couple of other brands do not qualify for the credit any longer; some others have only partial credit left).

However, starting in 2023, the following new limitations will take effect:

  • Your dream SUV or a pickup should cost $80,000 or less ($55,000 threshold for other vehicles).
  • Your modified adjusted gross income cannot exceed $150,000 (single), $300,000 (married).

There are some other positive changes coming from this new law. “Certain” used electric cars will now qualify for the lesser of $4,000 or 30% of the car’s sales price credit. Also, there will no longer be a need to count how many vehicles each car manufacturer has sold. Any car brand qualifies for the credit (see above for the price maximum).

There is a caveat, however. For new clean vehicles purchased after Aug. 16, 2022 (the date President Biden signed the legislation), the tax credit is generally available only if the qualifying vehicle’s final assembly occurred in North America (final assembly requirement).

How can you tell where your vehicle was assembled? According to guidance posted on Aug. 23 on the websites for both the U.S. Department of the Treasury and IRS, you can check the Department of Energy’s list of model year 2022 and 2023 electric vehicles that may qualify to see whether yours appears on the list. But the IRS cautions, “there may be vehicles on the Department of Energy list that do not meet the final assembly requirement in all circumstances.”

As a second step, enter the vehicle’s 17-digit vehicle identification number (VIN) into the National Highway Traffic Safety Administration’s VIN Decoder tool and view the “Plant Information” field at the bottom of the results page. This will identify where the searched vehicle was built.

There are other changes concerning electric cars that we will address in the future if we find it relevant to the everyday taxpayers.

The new law can potentially discourage a large group of people from buying electric vehicles who have been the main buyers of them so far. My hope is that the intent of the new law is to encourage auto makers to start producing affordable ($55K or less) cars and make that more possible for them.

The new law also is intended to make the purchase of an electric vehicle easier because one can “pass” an electric vehicle credit to the car dealer and immediately realize a $7,500 (or $4,000 on a used car) price drop. Again, while it seems helpful, I cannot even imagine how the car dealer would be able to determine whether the credit being passed along is actually valid and whether the vehicle buyer is actually earning less than $150,000 a year (or $300,000 if married). Potentially, this incentive would create another nightmare scenario in which the IRS must figure out how to validate credits coming from car dealers.

Specifics on Solar

Another increasingly popular topic of conversation since the new law went into effect is whether it’s better to have solar panels installed this year or to wait until 2023 or later. From a tax-savings standpoint, you will get the same 30% off the total price of solar panels, including installation, whether you do it in 2022 or wait until later. The credit was originally scheduled to decrease to 26% of the total cost this year, but thanks to the Inflation Reduction Act, it has been restored to 30%. The only tax-related decision for you to make is whether you have enough tax liability to offset the credit.

The tax code is currently so complex that I want to spend extra time on what tax liability actually means. It’s NOT the balance on your tax return. It’s your TOTAL tax. On 2021 Form 1040, the total tax is reported on Line 16. To take advantage of the entire solar panel tax credit, make sure that your expected 2022 liability is, at least, 30% of the projected solar panel cost.

For example, let’s says your total tax for 2021 was $20,000. You do not expect any major decrease in your income this year. So it’s reasonable to estimate that your total tax for 2022 would be about $20,000 as well. If you purchase a $30,000 solar panel system this year, you will be able to get the entire 30% of the cost back or, in this case, $9,000. It most likely will come as overpayment on your 2022 tax return, and you will be able to receive the refund sometime in 2023.

Alternatively, if you know you will install solar panels this year, you can file a new W-4 with your employer advising them to deduct less federal income tax for the rest of 2022. This way you keep more cash now, and your 2022 tax return won’t show a large overpayment. This approach is riskier because it’s not easy to figure out how much less you should pay in federal taxes on your payroll, and you’ll have to remember to change it back for the first payroll cycle of 2023. It’s easier for taxpayers making estimated tax payments: They can just reduce (or skip) their September and/or January installments for the anticipated credit.

I’d also like to offer a few words of caution:

  1. If your income in 2022 is lower than usual, and the 30% of the cost of the solar panel installation ends up being higher than your total 2022 tax liability, the unused part of the credit is gone forever. For example, let’s assume you had that $30,000 solar panel system installed this year, giving you the maximum credit of $9,000. If your tax liability is only $7,000 for the entire year, the credit will offset your tax liability entirely and the $2K extra will be lost. That’s how “nonrefundable” credits usually work. In this situation, I recommend spreading the initial and final payments for the solar system over two years if you can.
  2. If you do get a full tax credit for installing solar panels in 2022, make sure to calculate your 2023 estimated tax payments without planning for that credit to repeat (unless you install a different solar system, let’s say, in your secondary home).

More Energy-Efficiency at Home

Lastly, let’s talk about the tax credit for adding energy-efficient improvements to your primary home. The rules have changed almost every year, in some cases without anyone knowing whether the credit was available until November, when all the prior year’s returns had been filed. Besides, the credit had a lifetime maximum of only $500 — which never made sense to me. How are we expected to keep records?

Let’s say I installed a new hot water heater in 2015 and took a whopping $150 credit. I still have $350 to use. But what are the chances that a) I will be able to find time to go through my tax returns to look for any energy credits I might have already taken, b) my accountant would do the same, and c) the IRS will ever been able to verify whether I still have some of that lifetime credit available? Laws written like this make very little sense.

Fortunately, there’s good news on this front! Starting with tax year 2023, the lifetime limit is being replaced with the annual limit of $1,200. Thus, if you’re deciding when to install a new hot water heater, January 2023 would be a better move from a tax-planning perspective. (Of course, if your current hot water heater quits in December and must be replaced ASAP, it’s okay to choose hot showers over tax credits and replace it this year!) More on this in future Ludmila CPA’s blogs and newsletters.

This is a lot to digest and we’re all still learning about the various tax changes associated with the Inflation Reduction Act. If you want to chat about your own situation and determine the right course of action for you, give us a call! We’d be happy to talk it through with you.