How the Inflation Reduction Act impacts your climate-conscious clients
November 14, 2022
By Daniel F. Rahill, CPA, JD, LL.M., CGMA
The Inflation Reduction Act of 2022 includes significant climate-related provisions that may impact some of your tax clients. Before heading into your next busy season, here’s what you need to know.
On August 16, 2022, the Inflation Reduction Act of 2022 (IRA or the act) was signed into law, which includes significant provisions that’ll impact millions of Americans over the next decade, including more than $200 billion in tax incentives designed to combat climate change.
With Americans battling record inflation, higher gas prices, and the rising effects of climate change, consumers and businesses today are increasingly investing in cost-effective energy alternatives. As such, these tax incentives are likely to draw up some questions from your tax clients. Before you gear up for the coming busy season, be sure to review these five IRA tax credits so you can best advise your clients.
1. Provisions for sustainable energy households
To incentivize a broader move to sustainable energy nationally, the IRA utilizes tax credits to accelerate U.S. manufacturing of solar panels, batteries, and critical minerals processing. The act’s measures are intended to not just fight climate change and increase energy efficiency, but to lower overall energy costs by an estimated $500 for each American household annually.
2. Nonbusiness energy property credit
Under current law, individuals are allowed a tax credit for specified “nonbusiness energy property” expenditures if the property was placed in service before January 1, 2022. Nonbusiness energy property includes building envelope components (i.e., insulation, exterior windows and doors, and certain roofing materials) as well as building system components (i.e., water heaters, heat pumps, central air, etc.) that meet specified energy efficiency standards. The current credit includes a principal residence requirement and is subject to a lifetime limit. The credit for a tax year is limited to the excess of $500 over the aggregate credits allowed to that taxpayer for all previous tax years ending after 2005.
- Renames the credit to “energy-efficient home improvement credit,” increases the credit amount, and extends the credit to January 1, 2033.
- Revises the energy efficiency certification requirements for building envelope components and substantially expands the definition of residential energy property expenditures.
- Repeals the requirement that expenditures must be made with respect to the taxpayer’s principal residence.
- Repeals the lifetime credit limitation and instead limits the allowable credit to $1,200 per taxpayer per year. These provisions generally apply to property placed in service after December 31, 2022.
3. Residential energy-efficient property credit
Under current law, individuals can claim the “residential energy-efficient property” credit for solar electric, solar hot water, fuel cell, small wind energy, geothermal heat pumps, and biomass fuel property installed in residences prior to 2024. In contrast to the nonbusiness energy property credit discussed above, expenditures on equipment at second homes and vacation homes are eligible for the credit. The amount of the current credit is 26 percent of qualified expenditures for property placed in service after December 31, 2019, and before January 1, 2023, phasing down to 22 percent for property placed in service after December 31, 2022, and before January 1, 2024.
The act expands the number of credits designed to lower the cost of residential energy-efficient improvements, such as HVAC systems and solar and water heaters. These tax credits are extended for residential clean energy expenses, including rooftop solar, heat pumps, and small wind energy systems. Taxpayers can also receive a 30 percent credit for expenditures through 2032, which then phases down to 26 percent and 22 percent for 2033 and 2034, respectively.
Overall, the 30 percent tax credit could save your clients, on average, $7,000 on a typical rooftop solar system. Homeowners with home-use batteries connected to their solar systems could also see tax incentives that effectively reduce their costs by 30 percent.
4. Energy-efficient home credit
This current credit is available to qualified contractors for qualified new energy-efficient homes acquired by a homeowner before January 1, 2022. The act extends this credit to homes acquired through 2032. Under the act, the amount of the credit ranges from $500 to $5,000 depending on which energy efficiency requirements the home satisfies and whether the construction of the home meets prevailing wage requirements. These provisions generally apply to dwelling units acquired after December 31, 2022.
5. Clean vehicle credits
The IRA also provides tax credits of up to $7,500 for consumers who buy new electric vehicles (EVs) and adds a $4,000 credit (or 30 percent of the purchase price, whichever is less) to purchase a used EV—though several stipulations may make it difficult for many vehicles to qualify.
To start, there are price caps, as the credit isn’t allowed for cars with a manufacturer’s suggested retail price over $55,000, or for vans, SUVs, or pickup trucks with a manufacturer’s suggested retail price over $80,000. The sale price for the used EV must be $25,000 or less.
Under the new law, the new EV credit is no longer phased out after a manufacturer sells 200,000 vehicles, but new EVs must meet domestic manufacturing standards where a percentage of critical minerals used in the car must have been extracted or processed in the United States or a country with which the U.S. has a free trade agreement. This requirement is phased in and applies to 40 percent of such minerals before 2024 and 80 percent after 2026.
Similar restrictions also apply to battery components. For example, to get 50 percent of the tax credit, half the value of the battery components used in the car must be made in North America. The other 50 percent must be linked to the value of critical mined or processed minerals in the U.S. or by free-trade partners. Given that China is the global hub for battery-mineral refining, automakers will be challenged to meet these requirements.
Another stipulation to consider is that the credit is only allowed once per vehicle. Also, the new vehicle credit isn’t allowed for taxpayers whose modified adjusted gross income (MAGI) exceeds certain thresholds ($300,000 on joint returns, $225,000 for head of household, and $150,000 for single taxpayers).
The changes for new EVs are generally effective for vehicles placed in service after December 31, 2022 and will expire after 2032. Taxpayers who purchased a new EV or entered a written binding contract to purchase one between January 1, 2022, and August 15, 2022, but placed it in service on or after August 16, can elect to have the former credit rules apply to that vehicle.
To qualify for the $4,000 used EV credit, the buyers must have a MAGI under $150,000 on joint returns, $112,500 for head of household, and $75,000 for single taxpayers. The used EV credit applies to vehicles acquired after December 31, 2022.
Like the Tax Cuts and Jobs Act of 2017 and recent pandemic relief legislation, the IRA will likely generate many questions from your tax clients. And, like previously passed legislation has shown us, the U.S. Treasury and IRS likely won’t be able to provide sufficient guidance before the IRA’s provisions become effective. Therefore, be prepared for an iterative process of updated guidance issued over time.
Reprinted courtesy of Insight, the magazine of the Illinois CPA Society. For the latest issue, visit icpas.org/insight.
Illinois CPA Society member Daniel F. Rahill, CPA, JD, LL.M., CGMA, is a managing director at Wintrust Wealth Management. He’s also a former chair of the Illinois CPA Society Board of Directors and a current board member of the American Academy of Attorney-CPAs.
This information may answer some questions but is not intended to be a comprehensive analysis of the topic. In addition, such information should not be relied upon as the only source of information; professional tax and legal advice should always be obtained.
Upcoming courses related to the Inflation Reduction Act
KyCPA offers several upcoming courses online regarding the Inflation Reduction Act.