The New Electric Vehicle Tax Credit: Mind the Details

This Inflation Reduction Act tax break comes with income limitations, and not every electric vehicle will qualify.

Now that President Joe Biden has signed the Inflation Reduction Act into law, advisors should begin to dig into the details so that their clients are maximizing the benefit of the new energy tax credits. The tax credits for electric vehicles are changing — and for many clients, may become much more substantial in the coming years.

While questions do exist about how the tax credits will work for the 2022 tax year, many consumers may be attracted to the possibility of a new way to save on taxes. The new credits do contain a number of limitations that mean some taxpayers and electric vehicles won’t qualify for the credit — and taxpayers should pay close attention to the details to avoid an unpleasant surprise after buying an electric vehicle.

Expanded Electric Vehicle Tax Credits: The Basics

The Inflation Reduction Act expands the electric vehicle tax credit for electric vehicles placed into service after Dec. 31, 2022 for 10 years, through 2032. Taxpayers who buy qualifying vehicles will qualify for a tax credit of up to $7,500 for new vehicles. 

For used electric vehicles, the maximum credit will equal $4,000 or 30% of the vehicle’s cost, whichever is less. Used electric vehicles qualify only if they’re purchased for personal use, rather than for resale.

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The exact amount of the available credit will depend on various factors, including whether minerals in the vehicle’s battery are sourced from qualifying countries and where the vehicle is assembled. For example, taxpayers who purchase a vehicle where 40% of the critical minerals used in the battery are sourced from a qualifying country could be eligible for a $3,750 tax credit. Beginning in 2023, half of the battery’s components must be assembled or manufactured in North America to qualify for the remaining $3,750 credit.

The percentage limitations will increase over time, which could make it more difficult to find a qualifying vehicle unless manufacturers modify their processes.

The tax credit itself is also expanded so that it covers more types of vehicles, to include any new qualified fuel cell motor vehicle. That means qualifying vehicles are expanded to include more than qualified plug-in electric drive vehicles — for example, hydrogen cell fuel cars will now qualify.

To claim the tax credit, the taxpayer must include the vehicle identification number, or VIN, on their tax return for the year. The expanded tax credit applies to vehicles placed into service after 2022 (note that clients who have written binding contracts in 2022 will qualify if the vehicle is actually placed into service in 2023). If the vehicle was purchased in 2022, the old rules for claiming the credit continue to apply.

Income Limits and Restrictions

The newly expanded electric vehicle tax credits are intended to provide benefits for lower- and middle-income clients. As such, they come with income restrictions and limitations. The credit is unavailable to single taxpayers who earn more than $150,000 per year, joint filers who earn more than $300,000 per year and heads of households who earn $225,000 or more per year.

Certain luxury electric vehicles are also excluded. If the manufacturer’s suggested retail price, or MSRP, on an SUV, van or truck is over $80,000, the buyer is not entitled to the credit. The credit is unavailable if the MSRP on a car is over $55,000. If the vehicle was used (defined as at least 2 years old), the cost of the pre-owned vehicle cannot exceed $25,000.

There are also restrictions on where the vehicle was manufactured. To qualify, final assembly of the clean vehicle must have occurred in North America. That requirement is effective as of Aug. 16, 2022 (the date the Inflation Reduction Act was signed into law). Further, a certain amount of the minerals used in the vehicle’s battery must be sourced from North America or certain other countries that have free trade agreements with the U.S.

Starting in 2023, however, existing sales caps will be removed so that automakers that currently offer electric vehicles can produce more electric vehicles. Before the Inflation Reduction Act, manufacturers that produced more than 200,000 electric vehicles didn’t qualify for the credit.

Currently, the average electric vehicle costs about $66,000. These limits and restrictions are designed to reduce that price so that average Americans find electric vehicles more affordable.

Conclusion

Not every vehicle will qualify for the electric vehicle credits — meaning that it might be confusing when clients attempt to purchase a clean vehicle. The Department of Transportation, however, has provided an online tool so that consumers can enter the vehicle identification number, or VIN, to determine whether they would be eligible to claim the credit after purchase.

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