The Inflation Reduction Act EV Tax Credits Explained

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The Inflation Reduction Act EV Tax Credits Explained

Key Points

  • The tax credit was put in place to assist EV startups in making profits without charging high prices.
  • One of the factors which influences eligibility is the location of assembly.
  • The new Clean Vehicle Credit regulations are based on price and the source of the materials used.

The Inflation Reduction Act launched a seismic shakeup of electric tax credits alongside its other provisions. Taking effect August 16th, 2022, the Act changes the eligibility of most EVs formerly offering tax credits to buyers.

Many EVs that used to qualify for government tax benefits no longer do, thanks to sweeping amendments to the rules. Some cars still qualify for the Clean Vehicle Credit of $3,750 to $7,500, and those bought before August 16th still might qualify for the older credit scheme.

The government mostly bases changes in eligibility on two major factors. One factor is whether the final assembly of the EV takes place in North America. The other is the source of the battery materials, such as lithium, cobalt, nickel, or iron, depending on construction. Some provisions of the new Act are already in effect while others won’t start until 2023, and a few are phased in over years.

Here’s what you need to know about the changes in EV tax support.

The Old EV Tax Credit

To understand how the Inflation Reduction Act is completely reforming EV tax credits, it’s worth taking a quick look at the earlier system. The government dubbed the credit the “Federal Plug-In Electric Drive Vehicle Credit.” As this rather clunky name suggests, the plan was minted when plug-in hybrid electric vehicles (PHEVs) were more common than EVs. Its structure reflects this focus on PHEVs and is part of the reason the government now deems them obsolete.

As Solar Reviews observes, the former tax credit’s foundation is the kWh (kilowatt hour) capacity of a vehicle’s battery. It offers a $2,500 tax benefit for vehicles with a 5 kWh or larger battery, plus $417 per kWh above 4 kWh. As a result, a 5 kWh battery gives a $2,917 tax credit, a 6 kWh battery creates a $3,334 credit, and so on. The government chose a $7,500 tax credit as the upper limit, a maximum reached with a 16 kWh battery.

Other Tax Credit Limitations

Officials originally designed the tax credit to help EV startups operate profitably without high prices driving away customers. As a result, they decided the tax credit should phase out once an EV company started making robust sales.

Once company sales of all models in their lineup climbed above 200,000, the tax credit started phasing out. The government cut tax credits by 50% for the 6 months after the 200,000th sale, and by another 50% for the following 6 months. 12 months after the 200,000th sale, none of the company’s current or future EVs qualified, as TurboTax describes.

As an example with an EV qualifying for the full $7,500 tax credit:

  • 1-200,000 sales: full $7,500 tax credit
  • 200,001+ sales, within 6 months: $3,750 tax credit
  • 200,001+ sales, within 6 to 12 months: $1,875 tax credit
  • 200,001+ sales, more than 12 months: $0 tax credit

The 200,000 unit sales cutoff is why popular EVs like the Tesla Model 3 no longer receive tax credits. Policymakers made several attempts to lift the 200,000 sales limit. One example was Congressman Peter Welch’s July 2nd, 2018 bill, H.R.6274, to eliminate the limit through 2028. None of these initiatives took effect before the whole system was scrapped in favor of the new rules.

The Clean Vehicle Credit System

The new Clean Vehicle Credit rules introduced by the Inflation Reduction Act focus on price and the source of materials used.

Both EVs and plug-in hybrids (PHEVs) can qualify for the tax credit. However, the vehicle must have a battery with a minimum of 7 kWh capacity. It must also be capable of recharging that battery by plugging it into an external power source. Thus, hybrids without plug-in capability are excluded.

In addition to these rules, a company must carry out the final assembly of an EV in North America for that vehicle to qualify. The Congressional Research Service published details of the requirements in an August 24th, 2022, report available online.

Critical Minerals Requirement

Congress’ published requirements say half of the $7,500 tax credit, or $3,750, depends on “critical minerals.”

The lawmakers specify that 40% of an EV battery’s “critical minerals” must come from the USA or a country with a free trade agreement with America. This goes into effect in 2023, then increases 10% yearly thereafter. The maximum critical mineral requirement is 80% in 2027 and subsequent years.

The U.S. Geological Survey published a list of 50 “critical minerals” early in 2022. While engineers don’t use the majority of these while building lithium-ion batteries for EVs, several key minerals appear on the list. These include aluminum, cobalt, lithium, magnesium, manganese, and nickel.

Electric car EV driving on road
The rules have amended for which cars are eligible for EV tax credits.

©Alexander Steamaze/Shutterstock.com

Battery Component Assembly Requirement

Getting the other $3,750 credit depends on what percent of the EV battery’s components were made or assembled in North America.

The use of “North America” here in the official document indicates that credit is available for batteries built in either Canada or the USA. Initially, in 2023, the rule demands that 50% or more of the battery must be manufactured or assembled on the continent. This requirement rises to 60% for 2024 and 2025, then 10% more annually until 100% is reached in 2029.

“Foreign Entity of Concern”

Lawmakers added another layer of complexity by disqualifying EVs made with materials sourced from a “foreign entity of concern.”

In 2024, EVs powered by batteries with any battery components manufactured, assembled or recycled by a “foreign entity of concern” lose Clean Vehicle Credit eligibility. In 2025, the law’s limits expand, also making EVs with critical minerals sourced from a “foreign entity of concern” ineligible.

“Foreign entities of concern” include terrorist organizations and governments that deal with them. The classification likely also includes countries under sanction, such as Russia during the Ukraine war.

Price and Income

The Inflation Reduction Act’s EV tax credit aims at making EVs more accessible to ordinary drivers. For this reason, it gives credits only to cheaper EVs. Passenger cars only qualify if they cost $55,000 or less. Vans, minivans, pickup trucks, and SUVs can receive the new tax credit provided their price isn’t more than $80,000.

The government also caps tax credit availability based on the EV buyer’s income. Single filing taxpayers can no longer receive the Clean Vehicle Credit when their income passes $150,000. Purchasers filing as a “head of household” lose eligibility at $225,000. Joint filing couples no longer qualify at $300,000. All income thresholds use adjusted gross income, or AGI, to determine eligibility.

Interestingly, some of these figures differ from those listed in the Inflation Reduction Act’s text. According to the bill, minivans provide a tax credit if their MSRP is $64,000 or less. The SUV cutoff is at $69,000, while the maximum eligible price for a pickup truck is $74,000.

Partial Exception: Used EVs

An exception to many EV qualification rules in the Inflation Reduction Act is a newly-introduced used EV tax credit. No previous rule offered a credit for used electric vehicles. Under the new scheme, TrueCar Adviser reports, used EVs at least two years old and selling for a maximum of $25,000 may qualify for a 30% tax credit. The maximum credit is set at $4,000.

This tax credit’s full set of qualifications is as follows:

  • Used EVs must be at least 2 years old (originally purchased in 2020 or earlier in 2022).
  • The used EV’s price cannot exceed $25,000.
  • The purchaser’s adjusted gross income cannot exceed $75,000 (single), $112,500 (head of household), or $150,000 (married and filing jointly).
  • The tax credit is 30% of the used purchase price with a cap of $4,000.
  • The EV must meet the “final assembly in North America” qualification like a new EV, though it is exempted from the “critical minerals” and “final battery assembly” requirements.

Inflation Reduction Act and Clean Vehicle Credit Summary

The complete list of qualifiers for a tax credit under the new rules is as follows:

  • The battery has a 7 kWh capacity or greater.
  • The battery is recharged from an external power source via a plug-in.
  • The final assembly was in North America.
  • The specified percentage of battery “critical minerals” must come from a country with free trade with the USA, or the USA itself (40% in 2023, 50% in 2024, 60% in 2025, 70% in 2026, and 80% in 2027 and the following years).
  • The specified percentage of battery components must be manufactured or assembled in North America (50% in 2023, 60% in 2024 and 2025, 70% in 2026, 80% in 2027, 90% in 2028, 100% in 2029 and the subsequent years).
  • From 2024, it must not use battery components made or assembled by a “foreign entity of concern.”
  • From 2025, it must not use critical minerals extracted by a “foreign entity of concern.”
  • The purchaser-adjusted gross income (AGI) is no greater than $150,000 (single), $225,000 (head of household), or $300,000 (married and filing jointly).
  • Used EVs are treated differently as described above.

An EV and its purchaser must meet all of these requirements to enable the full $7,500 tax credit, or any credit at all. As of early September 2022, the guidelines might still be in flux, depending on the final rules issued by the Treasury Department.

Currently Available Vehicles and the Clean Vehicle Credit

While most of the Inflation Reduction Act’s EV tax credit provisions won’t apply until 2023, the North American final assembly took effect on August 16th, 2022.

The exception is a grandfather clause for EVs purchased before August 16th but not delivered before that date. This includes what the IRS calls “written binding contracts,” where a purchaser put a reservation on an EV and paid a non-refundable deposit. This deposit must be at least 5% of the final purchase price. If these qualifications are met, the old tax credit applies. This exception applies even though the EV buyer is technically taking delivery and paying most of the purchase price after the August 16th cutoff.

The new rule eliminates most existing EVs from tax credit eligibility. Approximately 70% of currently available hydrogen fuel cell vehicles, plug-in hybrids (PHEVs), and EVs don’t qualify under the new rules. The Alliance for Automotive Innovation reports no current EV models will qualify once the 2025 critical minerals sourcing rule goes into effect.

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Frequently Asked Questions

What EV models still get a tax credit under the new rules?

Green Car Reports estimates 8 EVs will qualify for the Clean Vehicle Credit in 2023 once price caps and final assembly rules apply.  These include the Chevrolet Bolt, Ford Mustang Mach-E, Ford E-Transit van, Ford F-150 Lightning pickup, Nissan Leaf, Volkswagen ID.4, Tesla Model Y, and Tesla Model 3.

Does a reservation for a future EV protect that EV’s previous tax credit under the Inflation Reduction Act?

An EV only qualifies for the previous tax credit if a binding contract, with a 5% or greater non-refundable deposit, exists. Since the rule was unknown until a short time ago, most reservations were refundable and below 5% and therefore don’t qualify. Many people who reserved EVs that originally qualified for the $7,500 tax credit will no longer receive it.

Will a point arrive when no EVs qualify for tax credits?

If EV manufacturers don’t change their supply chain to eliminate “critical minerals” supply from foreign countries, yes. Assuming no changes to the rule or supply chains, no current EV model will qualify as of January 1st, 2025.

How long will it take automakers to start offering compliant EVs?

Some commentators are dubious about how quickly EV automakers can or will meet the requirements. Automotive News quotes consultancy AlixPartners chief, Mark Wakefield, as saying there’s “not going to be a flood” of EVs matching the new rules.” Wakefield estimates it could take 4 years before new models specifically designed for the Clean Vehicle Credit appear in showrooms. This would mean the first fully compliant models might not be available until 2026 or 2027.

Do only electric vehicles (EVs) qualify for the Clean Vehicle Credit?

Plug-in hybrids (PHEVs) also qualify as long as their battery has a 7 kWh minimum capacity and they plug in to recharge.

Can used EVs get a tax credit under the Inflation Reduction Act rules?

Yes, certain used EVs can get up to $4,000 tax credit.

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