How do tax credits for electric cars work?

The Inflation Reduction Act, which passed the Senate this weekend, expands federal tax credits for electric vehicles. The bill removes a cap that prevents owners of popular electric vehicle manufacturers, such as Tesla and General Motors, from receiving the credit. It also expands the credit to used electric vehicles.

More than 7 million fully-electric or hybrid vehicles were registered in the US in 2021, according to data from the Department of Energy. Electric cars make up less than 4% of total passenger cars in the US. The federal government and some states provide tax incentives to individuals who purchase electric vehicles. These tax credits can add up to more than $10,000 in some states.

The Department of Energy defines electric-drive vehicles as those that “use electricity as their primary power source or to improve the efficiency of conventional vehicle designs.” From this definition, there are three major categories of electric vehicles: all-electric^[1], plug-in hybrid^[2], and hybrid^[3]. Hybrid vehicles are the most popular, making up about 70% of all electric vehicle registrations in 2021.

How does the federal tax credit for electric vehicles work?

In 2010, Congress created the qualified plug-in electric vehicle credit, which offers up to $7,500^[4] in tax credits for those who purchase new electric vehicles. Only fully electric and plug-in hybrid vehicles qualify for the federal tax credit program. Used and leased vehicles do not qualify.

The credits are nonrefundable, meaning they can only go toward reducing the taxes owed and cannot go towards a tax refund. So, if someone owes less than $7,500 in federal taxes, they wouldn’t get the full benefit of the credit when buying an electric vehicle.

There also is a cap on how many cars per manufacturer can qualify. After a manufacturer sells 200,000 vehicles, the credit begins to phase out. The cap is 200,000 vehicles total, not per year. Tesla and General Motors have met that cap, so any cars purchased by those manufacturers are currently not eligible for the credit.

In 2019, 162,686 returns claimed the tax credit, which is about 25% of qualified cars purchased that year. The average credit claimed per return was $3,952, slightly more than half the maximum amount.

How does the Inflation Reduction Act change federal tax credits for electric vehicles?

The Inflation Reduction Act will eliminate the 200,000-vehicle cap that prevented buyers of popular electric vehicle companies, like Tesla and General Motors, from receiving the credit. The bill also includes up to a $4,000 tax credit for used electric vehicles, which were previously not eligible.

The bill also adds some new restrictions on who can claim the tax credit. Higher income buyers will no longer be eligible for the tax credit, which will now be capped at $150,000 for single filers and $300,000 for joint filers.

There’s also a limit on which vehicles qualify for the credit. Cars costing more than $55,000 or pickups, SUVs or vans costing more than $80,000 will no longer be eligible. The law also limits the credit to vehicles assembled in North America as well as other production related restrictions.

Which states have the most electric vehicles?

Almost 30% of all electric vehicles in the US are registered in California. California was also the first state to adopt a zero-emission vehicle policy that requires manufacturers to sell a set number of electric cars a year. By 2022, 13 states and Washington, DC will have enacted similar standards.

State and local governments also provide monetary incentives for electric vehicle purchasers, in addition to the federal tax credit. These incentives include rebates, income tax credits, and excise or sales tax exemptions.

The most common type of state incentive are rebates, which pay a certain amount of money back to electric vehicle owners after the purchase of the car. Thirteen states offer rebates, the largest being Connecticut and Oregon, which provide up to $7,500 back to qualifying residents. Four states offer a state income tax credit like the federal program. Washington, Maryland, and Washington, DC offer excise or sales tax exemptions on the purchase of an electric vehicle.

In addition to tax credits and rebates for purchasing electric vehicles, some states provide additional incentives to electric vehicle owners. These can include exemptions from state emissions checks, access to high occupancy vehicle lanes, and discounts on highway tolls.

Utility companies at the state and local level also provide incentives for electric vehicle owners. These can include rebates for purchasing electric vehicles or chargers, specialty rates on electric bills, and discounts when charging cars at nonpeak hours.

Which states charge electric vehicle owners additional fees?

However, many states also charge additional fees for electric vehicle owners. These can range from about $50 per year to more than $300 per year.

Not every state provides a reason for the fees. But the two most cited reasons are to make up for the loss of gas tax revenue from electric vehicles or to help fund the expansion of electric vehicle charging stations. Gas tax revenue is often used to improve and maintain transportation infrastructure like highways and bridges.

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