The new tax credits for electric vehicles, explained

A big shift is happening 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 last-minute changes, automakers and car buyers will find themselves with new tax rules baked into this massive legislation after President Biden signs it into law.

According to experts, the changes are restrictive in terms of electric vehicles and the potential buyers who will be eligible. 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 look at how tax credits worked in clean vehicles, pre-IRA, in the United States. Currently, in certain cases, up to $7,500 is available as a tax credit for people who wish to purchase an electric vehicle or plug-in hybrid. “The amount of money you could credit against your taxes was based on battery size, although the battery size limits were so low, pretty much anything qualified for the $7,500,” says James DiFilippoSenior Policy Analyst at Atlas Public Policy.

The current system has important rules. One of them is that the $7,500 is a tax credit on how much someone might owe the federal government in taxes. For example, imagine a taxpayer owes exactly $7,500 in federal taxes for a certain year and has been careful with his payroll deductions, paying the exact amount throughout the year. Typically, at tax time in April, when that person and the IRS have reconciled, neither party owes anything. But, if that person purchased an electric vehicle that qualified for the $7,500 tax credit, then the IRS would issue them a check for that amount. “Generally the way it worked was people just got their money when they filed their taxes,” Di Filippo observes.

But Di Filippo points out that this system was not fair or equitable at all income levels. “The main implication in terms of equity is that the less you earn – at a certain threshold, basically – the less you get that credit.” Imagine you only had $1,000 in federal taxes, then the maximum you could earn in credit was also $1,000.

There is also another problem with the current system. The full $7,500 credit only applies to the first 200,000 qualifying vehicles manufactured by a company, then it tapers off and ends. “That particular cap was a point of contention,” adds Di Filippo. General Motors and Tesla, for example, have already exceeded that figure by 200,000.

Interested in learning more about all of this? Here is where it is stated in the US code.

The road ahead

If the IRA becomes law in its current form, the system described above will change. On the one hand, the limit of 200,000 disappears. “It’s going to be a huge help – in theory – for automakers like Tesla, as well as General Motors,” reflects Robby DeGraffindustry analyst at AutoPacific.

Another change prevents people who earn more than a certain amount of money annually from getting the credit. For example, households earning more than $300,000 a year are out of luck, at least in the tax credits department. In addition, there are caps on the price of vehicles: For example, a pickup truck that costs more than $80,000 would not qualify; others are capped at $55,000. In short, expensive vehicles are left out.

But other changes have to do with where a vehicle and its parts come from. “The vehicle must be assembled in North America,” explains Di Filippo. “And right away, that removes the eligibility of a number of current vehicles on the market.”

An ID.4 made by Volkswagen in Tennessee is fine with at least that requirement, but a Hyundai Ioniq 5, which is made overseas, not so much.

[Related: Can the Chips and Science Act help the US avoid more shortages?]

Then there are other requirements regarding the provenance of vehicle components. In particular, questions of where battery components (like cells) are assembled and where battery minerals, such as lithium and cobalt, are mined and processed are in the spotlight. Whether or not a car manufacturer checks these boxes determines the amount of the $7,500 that may apply. “The mineral content and battery components are really two halves of that $7,500,” says Di Filippo. (In other words, some vehicles might qualify for smaller tax credits depending on which boxes they tick.)

“The battery components must be manufactured and assembled in North America, and if you meet the thresholds, which increase over time – from 2023 it’s 50% – then the vehicle qualifies for $3,750” , he explains.

As for the minerals that go into a battery (here’s more on how a lithium-ion battery works), that part is tricky.

The new restrictions state that by 2023, 40% of critical battery minerals must come from a country with which the United States has a free trade agreement. This percentage requirement increases over time. And by 2025, none will be able to come from China (which refines lithium) or Russia, for example. So even if the lithium was mined in Australia or Chile, a problem could still exist if it was processed in another country.

“My understanding is that no automaker can meet that 40% target in 2023, right now,” says Di Filippo. “They may be able to manage and change that.”

The take-out sale

Ultimately, the changes are binding, says Di Filippo. “From a consumer perspective, this is likely to reduce, or almost certainly reduce, the number and value of EV credits in the future at least for the next few years.”

There are, however, a few bright spots. The first is that there will be up to $4,000 of tax credit that a person can get when buying a used electric vehicle from a dealership, provided their income is below a certain level ($75,000 for an individual, for example). “The used electric vehicle tax credit, or clean vehicle credit, is a huge benefit for consumers looking to get into electrification,” says DeGraff of AutoPacific.

Also, previously the tax credit was money that someone usually received when they filed their taxes; now there will be a way for it to take effect when people actually buy the vehicle from a dealership.

Nevertheless, there is widespread concern about the effects of legal changes on the electric vehicle market, as the CEO of the Automotive Innovation Alliance wondered in a blog post titled: “What if no electric vehicle is eligible for the tax credit for electric vehicles? It could happen.”

Ultimately, Di Filippo sees some improvements with the new policies over the old ones, but with one important caveat. “This is a win for fairness in the electric vehicle tax credit policy space – of course, none of this matters if no one can buy a vehicle that can actually benefit from the tax credit,” he said to himself.

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