How Do Electric Car Tax Credits Work?

Consumers considering an electric vehicle right now may want to weigh how the current and future tax credits on zero-emissions cars compare and could affect any upcoming buying decisions.

The Inflation Reduction Act moving through the United States Congress includes provisions for electric vehicle tax credits that will reshape how Americans buy electric cars and plug-in hybrids. Read on to learn the impact. We will tell you about what changes you can expect, what the existing federal tax incentives look like, along with information about state and local rebates that when combined, help defray the cost of buying an EV.

RELATED STORIES: Senate Deal Would Remake EV Tax Credits

What the Potential EV Tax Credits Look Like

  • Extends $7,500 tax credit. This latest initiative could extend the current incentives.
  • Discount up front. The revived measure could change the rebate to a discount at the time of purchase.
  • Caps EV price tags. The new measure would restrict the incentives to low-emissions trucks, SUVs, and vans with manufacturer suggested retail prices (MSRPs) up to $80,000, and cars up to $55,000. This would eliminate many current EVs from eligibility.
  • No limits for manufacturers. In the proposed measure, manufacturers will not be limited on incentives to the first 200,000 EVs sold.
  • Used electric vehicle rebate. Anyone considering a used electric car under $25,000 could obtain a new $4,000 tax credit.
  • Income caps to qualify. The initiative would also limit the rebates to individuals reporting adjusted gross incomes of $150,000 or less on taxes, $225,000 for those filing as head of household, and $300,000 for joint filers.
  • Ineligible cars become eligible. Additionally, the measure would allow carmakers like Tesla and General Motors, which had run out of available credits under the old plan, to be eligible for them again. However, many of their products would still not qualify due to price caps.
  • New rules on manufacturing locations. As soon as the rules go into effect, cars must be assembled in North America to qualify for the subsidy. After 2023, cars with Chinese-made battery components would be ineligible, and critical minerals must come from certain U.S. trade partners. These rules would render many current EVs ineligible. Auto industry lobbyists are working to change them as the bill moves to the House.

Still, car prices continue to rise, making even the new deal out of reach for some EV buyers. According to Kelley Blue Book research, the average transaction price of a new electric car reached $66,997 in June, a 14% jump from a year ago.

The industrywide average that includes gas-powered vehicles and electric cars hit $48,043, in the same timeframe.

What the Existing EV Tax Credits Provide

Existing government incentives of up to $7,500 for electric and fuel-cell vehicles, and plug-in hybrids do not place any restrictions on purchase price. The current EV tax credits came out of a 2009 bill and still apply to 2010 and newer plug-in electric vehicles. Here’s how it works:

You Don’t Get the Tax Credit Right Away

You must front the money for your car. Manufacturers often advertise the incentive as a discount on the car’s price. Instead, it’s a government policy that allows you to claim up to $7,500 in credit against the federal income taxes you owe in the year in which you buy the car. In other words, it reduces your tax liability. If you’re eligible for a refund, you’ll get whatever the amount of your credit on top of that.

Buyers must still pay the price they negotiate for the car (whether paying it in cash or folding it into a car loan). They can then claim the credit the next time they file their taxes. The credit lowers your tax liability. If your tax bill is lower than the credit, you’ll receive the balance as a refund. However, you can’t roll that credit or any remaining balance into the next tax year.

It Applies Only to New Cars

Currently, there’s no tax credit for buying a used electric car, no matter how efficient it is. If the Inflation Reduction Act becomes law, it will introduce a rebate of up to $4,000.

Leased Vehicles Don’t Qualify

If you’re leasing a new EV, the tax credit will go to the manufacturer offering you the lease. They may choose to apply that credit to help lower your monthly payments. But they aren’t required to do so. It’s a point you can bring up in negotiations.

It Applies to EV, Plug-in Hybrid, and Fuel Cell Vehicles

The law states that the credit applies to road-going vehicles that are charged from an external source and have battery packs with capacities of 4 kilowatt-hours or greater. The base credit is $2,500 with $417 per kWh above 4 kWh, not to exceed $5,000 for the full $7,500 credit. This formula applies to all battery-electric vehicles as well as plug-in hybrids. 

In practice, here’s how the tax credit works. A standard 2022 Toyota Prius hybrid will not qualify because it can’t be plugged into an external power source. But the 2022 Toyota Prius Prime will, because of its plug-in capability, which is good for the first $2,500 of the credit. Because of its 8.8 kWh battery, it will be eligible for an additional $2,000 in credits. The 2022 Toyota RAV4 Prime plug-in hybrid, which has a larger 18.1 kWh battery, is eligible for the full $7,500 credit. 

That  $7,500 credit also applies to hydrogen fuel-cell cars, such as the Toyota Mirai, Honda Clarity, or Hyundai Nexo. However, those make sense only for buyers who live near one of America’s few hydrogen refueling stations, mostly concentrated in California. 

The U.S. Department of Energy maintains a list of vehicles that qualify for the tax credit and the amount buyers could deduct for them.

Some Electric Cars No Longer Qualify

Glancing at that list, however, you may notice that some pure electric vehicles don’t qualify. Why? They’re victims of their success. The full credit is available on the first 200,000 vehicles a manufacturer builds. Beyond that, the credit begins to sunset. It winds down gradually, first dropping to half, then expiring about a year after that 200,000th sale. 

Toyota, and its luxury brand Lexus, recently crossed the threshold, so its credits will wind down. Other manufacturers have completely exhausted their available credits. You won’t qualify for any incentive to buy a Tesla or General Motors car, no matter how efficient.

Nissan is next in line to lose the credit. As of this writing, buyers of the 2022 Nissan Leaf can still qualify for the full amount.

State and Local Incentives Near You

Though the federal government’s effort makes up the lion’s share of government EV discounts, some states and local governments offer incentive programs to help new car buyers afford something more efficient. These can be tax credits, rebates, reduced vehicle taxes, single-occupant carpool-lane access stickers, and exemptions from registration or inspection fees.

States like California and New Jersey offer broad support for electric vehicle buyers. For example, residents in New Jersey buying a new or leased zero-emission vehicle can get a sales and use tax exemption. Additionally, the Charge Up New Jersey Program offers a rebate of up to $4,000 at the point of sale to residents who lease or buy a new EV or plug-in hybrids. The amount will vary based on the price of the EV and the electric range as rated by the EPA.

Idaho, Kentucky, and Wyoming are among states offering no support to individual EV buyers. The U.S. Department of Energy maintains an interactive list of state-level incentives, while Plug In America posts an interactive map of EV incentives.

Your Electric Utility May Help

Lastly, it’s not just governments that can help you with the cost of a new EV. Some local electric utilities provide incentive programs to help buyers get into electric vehicles (after all, they’re among the ones that benefit when you turn your fuel dollars into electricity dollars).

These can be as significant as a rebate. For example, the Nebraska Public Power District, offers a $4,000 rebate to customers who purchase a new electric car.

Should I Act Now or Wait?

The current federal program is generous and you can find affordable electric cars, including the 2023 Nissan Leaf, 2023 Chevrolet Bolt, and the 2023 VW ID.4.

However, if you have your heart set on a Tesla or perhaps GM’s new Hummer EV or Cadillac Lyriq, it wouldn’t hurt to wait. 

While a percentage, electric car sales growth is exponential, these vehicles represent a fraction of overall vehicle sales. If manufacturers build more EVs than the market wants, two things will happen. Prices will start dropping and you could find increased pressure for more federal subsidies in order to boost electric car sales. In either scenario, you win. 

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Editor’s Note: This article has been updated for accuracy since it was originally published.

Renee Valdes

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