Everything you need to know about EV tax credits and the Inflation Reduction Act
With the IRA in gear to become law, big changes are coming down the road for people who want to buy electric vehicles.
A big change is coming down the pike in how the federal government encourages people to buy clean cars like electric vehicles. The Senate passed the Inflation Reduction Act (IRA) on August 7, and the House of Representatives could pass it today. Barring any last-minute shifts, automakers and car buyers will find themselves with new tax rules that are baked into that massive legislation after President Biden signs it into law.
The changes, experts say, are restrictive in terms of what electric vehicles and potential buyers will qualify. However, it’s not all bad news, either.
Here’s a look at what to expect in the EV space if the IRA becomes law.
The current landscape
First, it makes sense to consider the way tax credits have worked in the clean vehicle space, pre-IRA, in the United States. Currently, in some cases, as much as $7,500 is available as a tax credit to people who want to buy an electric vehicle or a plug-in hybrid. “The amount of money that you could credit from your taxes was based on the battery size, although the battery size limits were so low, that basically everything qualified for the $7,500,” says James Di Filippo, a senior policy analyst with Atlas Public Policy.
The current system has some important rules. One of those is that the $7,500 is a tax credit towards the sum a person might owe the federal government in taxes. For example, imagine that a taxpayer owes exactly $7,500 in federal taxes for a certain year, and has been careful about their withholdings in their paycheck, paying the exact right amount throughout the year. Typically, come tax time in April, when that person and the IRS reconciled, neither party would owe anything. But, if that individual bought an EV that qualified for the $7,500 tax credit, the IRS would then cut them a check for that amount. “Typically, the way that it was working was people were just getting their money back when they filed their taxes,” Di Filippo observes.
But Di Filippo points out that that system wasn’t fair, or equitable, across income levels. “The key equity implication of that is that the less you earn—at a certain threshold, basically—the less you get in that credit.” Imagine you only owned $1,000 in federal taxes, then the maximum you could gain in a credit was also $1,000.
There’s another issue with the current system, too. The full $7,500 credit only applies to the first 200,000 qualifying vehicles a company makes, and then it diminishes and ends. “That particular cap was a point of contention,” Di Filippo adds. General Motors and Tesla, for example, have since surpassed that 200,000 figure already.
Interested in reading up more on all this? Here’s where it is spelled out in US Code.
The road ahead
If the IRA becomes law in its current form, the system outlined above will change. For one, the 200,000 limit disappears. “That is going to be a humongous help—in theory—for automakers like Tesla, as well as General Motors,” reflects Robby DeGraff, an industry analyst with AutoPacific.
Another change restricts people who make over a certain amount of money annually from getting the credit. For example, households that make more than $300,000 a year are out of luck, at least in the tax-credit department. Also, there are caps on the price of the vehicles: For example, a pickup truck that costs more than $80,000 would not be eligible; others are capped at $55,000. In short, expensive vehicles are left out.
But other changes have to do with where a vehicle—and the parts in it—comes from. “The vehicle must be assembled in North America,” says Di Filippo. “And right away, that removes quite a few current vehicles on the market from eligibility.”
An ID.4 made by Volkswagen in Tennessee is in good shape at least with this requirement, but a Hyundai Ioniq 5, which is made overseas, not so much.
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Then there are other requirements pertaining to the provenance of the vehicle’s components. In particular, in the spotlight are the questions of where the battery components (like the cells) are assembled, and where the minerals in the battery—such as lithium and cobalt—are mined from and processed. Whether or not an automaker checks these boxes determines how much of the $7,500 might apply. “The battery mineral content and components really make up the two halves of that $7,500,” Di Filippo says. (In other words, some vehicles could qualify for smaller tax credits based on what boxes they do tick.)
“Battery components have to be manufactured and assembled in North America, and if you meet the thresholds, which expand over time—starting in 2023, it’s 50 percent—then the vehicle is qualified for $3,750,” he explains.
As for the minerals that go in a battery (here’s more on how a lithium-ion battery works), that part is tricky.
The new restrictions state that by 2023, 40 percent of the battery’s critical minerals need to come from—be extracted from, and processed in—a country that the US has a free-trade agreement with. That percentage requirement increases over time. And by 2025, none can come from China (which refines lithium) or Russia, for example. So even if the lithium was mined in Australia or Chile, an issue could remain if it was processed in another country.
“My understanding is no car manufacturer can hit that 40-percent target in 2023, as of right now,” Di Filippo says. “They may be able to scramble and change that.”
Ultimately, the changes are restrictive, says Di Filippo. “From a consumer’s perspective, this is going to probably reduce, or almost certainly reduce, the number and value of EV credits going forward for the next few years at least.”
There are some bright spots, though. One is that there will be up to a $4,000 tax credit that a person can get when buying a used EV from a dealer, provided their income is below a certain level ($75,000 for an individual person, for example). “The used EV tax credit, or clean vehicle credit, is a huge perk for consumers looking to get into electrification,” says DeGraff, of AutoPacific.
Also, previously the tax credit was money that someone would generally get when they filed their taxes; now there will be a way for it to go into effect when people actually purchase the vehicle at a dealer.
But still, there’s general concern about the effects of the legal changes on the electric vehicle market, as the CEO of the Alliance for Automotive Innovation wondered in a blog post titled: “What If No EVs Qualify for the EV Tax Credit? It Could Happen.”
Ultimately, Di Filippo sees some improvements with the new policies over the old, but with an important caveat. “It’s a win for equity in the EV tax-credit policy space—of course none of that matters if nobody can buy a vehicle that can actually qualify for the tax credit,” he reflects.