The Democrats have finally reached a deal that would pass the the Inflation Reduction Act and expand EV tax credits to support green energy goals.
If successfully passed, the law could provide up to a $7,500 tax credit for the Tesla Model 3 Standard Range and the Model Y, so long as the buyer meets certain income limits (see details below). However, it is unclear whether Tesla will qualify for the battery requirements, so stay tuned.
Current Law on EV Tax Credits (max $7,500)
Under current law (26 U.S. Code, Section 30D), EVs are allowed a tax credit up to $7,500 for the first 200,000 EVs sold per manufacturer, after which the tax credit is slowly phased out.
The amount of the credit depends on the battery size of the EV: EVs with a 4 kWh battery qualify for a $2,500 credit, then $417 is added for every kWh above 4 kWh. An EV with a 16 kWh battery or higher qualifies for the full $7,500 credit.
Tesla and GM met the 200,000 EV cap and no longer receive the EV tax credit. Toyota recently met the 200,000 cap in Q2 2022; Toyota's EV credit will begin phasing out in Q4 2022 (with a 50% credit for Q4 2022 / Q1 2023, then 25% for Q2 & Q3 2023, then zero).
Proposed New EV Tax Credits (max $7,500)
The new legislation removes the 200,000 vehicle cap, so that Tesla, GM, and Toyota will once again receive EV tax credits. The legislation imposes other requirements:
Stricter Manufacturing Requirements:
1. Battery Minerals Requirement ($3,750 credit)
The EV must have a battery where a certain percentage of its critical minerals were--
(i) extracted or processed --
- (I) in the United States, or
- (II) in any country with which the United States has a free trade agreement in effect,
or (ii) recycled in North America" (Inflation Reduction Act of 2022, p. 386).
This percentage of critical minerals that meets the previous requirements goes up over time:
- 40% before January 1, 2024
- 50% in 2024
- 60% in 2025
- 70% in 2026
- 80% in 2027 and beyond
Currently, the U.S. has a free trade agreement with 20 countries:
- Australia
- Bahrain
- Canada
- Chile
- Colombia
- Costa Rica
- Dominican Republic
- El Salvador
- Guatemala
- Honduras
- Israel
- Jordan
- Korea
- Mexico
- Morocco
- Nicaragua
- Oman
- Panama
- Peru
- Singapore
- USMCA (United States-Mexico-Canada Agreement)
Notably missing are countries such as China, Russia, Argentina, and the Congo, where critical minerals for EV batteries are extracted (such as lithium and cobalt). In 2024 and 2025, battery materials from "foreign entities of concern" will be excluded from the EV tax credit. These "foreign entities of concern" include China, North Korea, and Iran (as well as countries on the terrorist watch list).
2. Battery Manufacturing/Assembly Requirement ($3,750 credit)
The EV battery size no longer matters as before. What matters now is that a certain percentage of the battery components "were manufactured or assembled in North America."
- 50% before January 1, 2024
- 60% in 2024 and 2025
- 70% in 2026
- 80% in 2027
- 90% in 2028
- 100% in 2029 and beyond\
3. Final assembly of the EV is in North America (previously specified "in the United States")
Previous considerations of extending EV tax credits specified that final assembly of the EV happens "in the United States" (H. R. 5376, tabled November 2021). This new bill broadens out to North America. This change helps Ford and GM, which manufacture some of their EVs in Mexico.
These battery mineral and battery manufacturing requirements are quite difficult to achieve, especially since China is the largest producer of EV battery minerals. Thus we will have to wait and see which companies qualify. John Bozzella goes so far to say that no current EVs will qualify!
Adjusted Gross Income (AGI) Caps:
To qualify, a person must not have a "modified adjusted gross income" above...
- $300,000 for a joint return or surviving spouse
- $225,000 for head of household
- $150,000 for all others
This income limit can be for either the tax year in which the EV is bought, or the preceding tax year. In previous versions of the proposed EV tax credit, the income cap applied only to income during the year the new EV was purchased.
The term "modified adjusted gross income" includes adjusted gross income (AGI) plus any income that was excluded under sections 911, 931, or 933 of the US Tax Code. These sections of the tax code allow individuals to exclude foreign earned income, foreign housing expenses, and income from Guam, American Samoa, the Northern Mariana Islands, or Puerto Rico from their AGI. But these excluded income sources must be added back in for the purposes of the EV tax credit.
EV Price (MSRP) Caps:
To qualify, the EV must cost less than...
- $80,000 for Vans and SUVs
- $80,000 for Pickup Trucks
- $55,000 for all other vehicles
For Tesla, the following models would qualify (according to pricing as of July 28, 2022):
- Model 3 Standard Range
- Both Model Ys
The Model X, Model S, Model 3 Long Range, and Model 3 Performance would all be excluded from the tax credit.
In the past, pre-order Cybertruck pricing was below $80,000, but Tesla has now removed pricing from their website, so it's unclear what the Cybertruck will cost in the future.
These income and price caps seem designed to prevent high income individuals from claiming the credit for expensive, high-end luxury EVs, although the income caps still seem fairly high in our opinion.
Effective Date of Tax Credit: After December 31, 2022
These new requirements will take effect in 2023, although there is a transition rule for cars purchased in 2022 (Inflation Reduction Act of 2022, pp. 386-87). For example, if someone bought a KIA electric vehicle (manufactured in Korea) in 2022 after this new law is enacted, it would not be eligible for the new tax credit, but the transition rule would allow such an EV purchase to still claim the previous tax credit.
Expiration of Tax Credit: December 31, 2032
Because the Senate is attempting to use budget reconciliation rather than the normal legislative process, these EV tax credits will expire in ten years on December 31, 2032. Budget reconciliation allows Democrats in the Senate to pass the bill on strict party lines and avoid a filibuster. If the Democrats used the traditional legislative process, the EV tax credits would be permanent.
Transfer of Credit to Car Dealers (Effective 2024)
The current EV tax credit favors those who can wait until the next tax year to claim the $7,500 credit. If you buy a car now in August 2022, you cannot claim the $7,500 credit until you file your taxes in 2023. In other words, you still pay the $7,500 now at the time of purchase, but will receive the tax credit next year.
The new EV tax credit allows for a "transfer of credit" to a car dealer (Inflation Reduction Act of 2022, pp. 378-83). This means that the car dealer can take the tax credit on next year's taxes, while giving you an equal payment of $7,500 at the time of purchase (whether in cash, or as a discount on the purchase price).
The new law even establishes a system of advance payments of the tax credit to car dealers, so that the car dealers don't have to wait until the next tax year to receive the transferred credits (Inflation Reduction Act of 2022, pp. 381-82)
Used Car Credit: $4,000, or up to 30% of sale price
The new bill provides for a used car credit up to $4,000 (or 30% of the sale price, whichever is less). This is a substantial increase from a previous proposal of a $2,500 credit for used EVs.
The used car must be 2 years old.
The used car credit is NOT subject to the limitations above regarding final assembly in North America, battery materials, or battery manufacturing/assembling.
However, the used car credit does have an adjusted gross income (AGI) limit. To qualify, a person must not have a "modified adjusted gross income" above
- $150,000 for a joint return or surviving spouse
- $112,500 for head of household
- $75,000 for all others
The term "modified adjusted gross income" includes adjusted gross income (AGI) plus any income that was excluded under sections 911, 931, or 933 of the US Tax Code. These sections of the tax code allow individuals to exclude foreign earned income, foreign housing expenses, and income from Guam, American Samoa, the Northern Mariana Islands, or Puerto Rico from their AGI. But these excluded income sources must be added back in for the purposes of the EV tax credit.
So, what's the effect on Tesla?
1. Plug-in Hybrid EVs with small battery packs will now get a full $7,500 instead of a much smaller amount. Many plug-in hybrids will now receive the same tax credit as fully electric vehicles.
The new bill is a net negative for Tesla because it now extends a full $7,500 tax credit to all hybrid vehicles, even those with very small batteries.
Whereas before a hybrid EV with a 4 kWh battery would only get a $2,500 credit, under the new law, a hybrid EV with a slightly larger 7 kWh battery would get a $7,500 credit (so long as it meets the battery materials and manufacturing requirements discussed above). The bill does increase the minimum battery size from 4 to 7 kWh.
Tesla only makes fully electric vehicles, whereas Ford, GM, Toyota, and others make a combination of hybrid, plug-in hybrid, and fully electric vehicles. For example, the Toyota Prius Prime Plug-in Hybrid has a 8.8 kWh battery and would receive a $4,502 credit under current law, but under this new law, the same Prius would receive a $7,500 credit.
Under the new EV tax credit, non-Tesla car companies will get higher EV tax credits than before on their plug-in hybrids that are primarily powered by gas.
2. Non-North American EV manufacturers will lose the EV tax credit.
Chinese, Korean, and European EV manufacturers would lose out on the tax credit unless they find work arounds. The definition of "final assembly" is very broad that foreign EV manufacturers could find ways of meeting the requirement: "the term ‘final assembly’ means the process by which a manufacturer produces a new clean vehicle at, or through the use of, a plant, factory, or other place from which the vehicle is delivered to a dealer or importer with all component parts necessary for the mechanical operation of the vehicle included with the vehicle, whether or not the component parts are permanently installed in or on the vehicle" (Inflation Reduction Act of 2022, p. 367).
This broad definition could give non-U.S. car manufacturers a loophole: the car could be essentially finished outside of the U.S. with a few parts not yet installed, so that these few components are permanently installed into the vehicle in the U.S. at the last minute and would still qualify for the tax credit.
EV manufacturers such as Nio and BYD would be at a $7,500 disadvantage when compared to companies that manufacture in North America (Ford, GM, Tesla, Toyota).
3. Tesla is not registered as a car dealer in many states, so Tesla has limited ability to provide an immediate rebate.
Laws in most U.S. states prohibit car manufacturers from selling directly to customers, which is why most car manufacturers work with independent dealerships. The dealership model should be obsolete. Tesla's e-commerce direct-to-customer model eliminates the middleman and the need for physical stores, much like Amazon.com has made in-person retail stores increasingly obsolete.
But many state laws prop up the old dealership method of sales. For example, look at all the states where Tesla is banned from registering as a dealer, where it can have limited direct sales, and where it can register as a dealer:
Even in states where Tesla is registered as a dealer, they have far fewer physical locations than other car companies. For example, in Arizona, Tesla only has six dealerships (Mesa, Tucson, Glendale, and three in Scottsdale -- see the Arizona Department of Transportation's "Valid Dealer Report"). Buyers might have to travel far to get to a Tesla dealership in Arizona.
This jumbled and confusing situation clearly favors Tesla's rivals, who can provide up to a $7,500 discount at the time of purchase if you buy at a car dealership. Tesla buyers in many states will have to wait until the next tax year to receive the $7,500 discount when they file their taxes. However, it's possible that Tesla might be able to find a work around -- for example, routing all its online sales through its officially licensed dealers in Arizona or California.
An immediate rebate helps lower income buyers who can't wait until the tax year (or would simply benefit from having $7,500 now rather than later).
4. Ford and GM still carve out a win for themselves.
There was previously a $4,500 bonus credit for EVs made by union labor (such as Ford and GM), but that bonus was opposed by Senator Joe Manchin and has been dropped.
However, the EV credits previously proposed that the final assembly of the EV must happen "in the United States," whereas now final assembly must be "in North America," which would extend the tax credit to cars assembled in Canada and Mexico. This change seems tailored to help Ford and GM, which manufacture some of their EVs in Mexico.
