How Does the Federal Tax Credit for Electric Cars Work?

Jessica Shea Choksey | Feb 01, 2022

Since 2010, the federal government has incentivized the purchase of new electric vehicles (EVs) with tax credits. To date, many EV and plug-in hybrid (PHEV) buyers have benefited from this program. But how exactly does the tax credit work, and which cars are eligible?

Money Federal Electric Vehicle Tax Credit

The Tax Credit

Virtually all EVs and PHEVs purchased since 2010 have been eligible for a federal tax credit up to $7,500. The exact credit amount is determined based on the capacity of the battery used to power the vehicle. Typically, an all-electric EV is more likely to qualify for the full $7,500 credit than is a PHEV, but many PHEVs are also eligible for the maximum credit. Hydrogen fuel cell electric vehicles (FCEV) are also included in this program.

Manufacturer Availability

Overall, the federal tax credit program’s availability varies by automaker, depending on the total number of electric vehicles a manufacturer has sold. The program is structured so that when a car company sells 200,000 eligible EVs, its tax credit begins to phase out in the second calendar quarter after crossing this threshold. Beyond that point, all electric vehicles sold by that manufacturer become ineligible for the tax credit.

Currently, the only two automakers that have reached the 200,000-units milestone are Tesla and General Motors (GM). They no longer benefit from the federal incentive program.

Recent legislation under the Biden administration could raise the 200,000-unit ceiling to 600,000 units, which would allow many automakers to remain eligible for the tax credit into the foreseeable future. The threefold increase would also allow GM to regain the credit for its new EV buyers. Tesla, however, has surpassed sales of 600,000 and will likely not see the tax credits again.

Vehicle Eligibility Criteria

There are several rules and requirements for a vehicle to qualify for the federal tax credit. They are as follows:

  • The vehicle must come from a manufacturer and be purchased new. It cannot be a home-built unit or a kit car.
  • The vehicle must be a plug-in electric car. It should rely on an electric motor for propulsion, have an onboard battery with a minimum capacity of 4 kWh, and be able to draw electricity from an external power source (a conventional hybrid vehicle does not qualify based on these criteria).
  • The vehicle can have a maximum gross vehicle weight rating of 14,000 pounds.
  • A qualified vehicle is only eligible for the federal tax credit once in its life.
  • Only the original buyer/owner is qualified for the tax credit, which is non-transferable. In a lease situation, the tax credit stays with the manufacturer or leasing company as the car owner (generally, the tax credit factors into the cost of the lease).
  • Buyers should not purchase the vehicle for the sole purpose of reselling it.
  • The vehicle must be purchased to be driven primarily in the United States. A vehicle relocated to another country may lose its tax credit eligibility.

Claiming the Federal Tax Credit

A tax credit means an EV buyer will receive up to a $7,500 reduction in their tax liability for the year. But this is a flat credit, which means it is only worth the full $7,500 if the individual’s tax bill is at least $7,500. If an EV buyer has a tax bill of, say, $3,000 at the end of the year, the EV tax credit can only be a maximum of $3,000. The IRS will not go over and above this total tax liability figure, and in this example, the remaining $4,500 of the EV’s total tax credit will not be useable. Furthermore, that unused portion will not apply to future years’ taxes.

Claiming the federal tax credit occurs when filing a yearly tax return. The IRS has included a section that addresses the purchase of electric vehicles. Like anything else tax-related, it is best to consult an accountant or tax expert to claim an EV tax credit correctly.

State Credits

In addition to federal credits, many states also offer incentives for purchasing a new EV. Depending on the state, cost relief can come as tax credits, cash rebates, or reduced registration and inspection fees.

New car buyers in California can get a cash rebate of $2,000 for electric vehicles and $1,000 for PHEVs. Under that same program, buyers of FCEVs may be eligible for a $4,500 tax rebate. Aimed at incentivizing buyers in the low-to-moderate income range, California’s EV rebate program has a $60,000 price cap, meaning vehicles that cost more than this amount do not qualify for the rebate.

The Total Benefit

2021 Nissan Leaf SV Plus White Front Quarter View

The federal tax credit combined with California’s cash rebate program can reduce the effective out-of-pocket cost of a new EV by up to $9,500. To illustrate, a 2021 Nissan Leaf has a sticker price of $31,670. After qualifying for federal and California incentives, the actual cost of this vehicle would be $22,170. The $2,000 cash rebate would come to the buyer immediately at purchase, and the other $7,500 would go to them at tax time, provided their tax liability is over $7,500.

Summary

In most cases, electric vehicles have higher price tags than their gas-powered counterparts. But after factoring in federal tax credits and state incentives, an EV can potentially become significantly less expensive. It is up to the buyer to learn which incentives apply and determine their tax liability to decide whether the purchase of an EV makes good financial sense.

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