Understanding The New Federal Tax Credit For Electric Cars — It’s Complicated

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The existing federal tax credit for electric cars dates back to 2005. It was originally intended to encourage manufacturers to build EVs at a time when almost nobody wanted them. Initially, it was going to be phased out after the first 200,000 EVs were registered in the US, but electric vehicle activists got that changed to the first 200,000 from each manufacturer in order to increase the total. The rationalization was that after a company produced 200,000 EVs, it wouldn’t need any further help from Uncle Sam.

A lot has changed over the past 17 years. Today, the looming threat of an overheating planet is much more evident to all of us. The 2015 Paris climate accords have placed a new emphasis on carbon reduction initiatives. As a result, the US government is now intent on speeding up the transition to clean energy and clean transportation. The Inflation Reduction Act of 2022 is meant to put some federal policy muscle into that process.

The IRA & Electric Cars

The IRA does not do away with federal tax credit for electric cars, but it does change the rules of the game considerably. Regarding the original tax credit, according to the IRS, “For vehicles acquired after December 31, 2009, the credit is equal to $2,500 plus, for a vehicle which draws propulsion energy from a battery with at least 5 kilowatt hours of capacity, $417, plus an additional $417 for each kilowatt hour of battery capacity in excess of 5 kilowatt hours. The total amount of the credit allowed for a vehicle is limited to $7,500.”

The upshot of all this is that a car must have at least an 18 kWh battery to qualify for the full tax credit. The IRS also says the credit is only available for the purchase or lease of a vehicle. If it is acquired for resale, no credit is available, which may deter some of the people who have discovered how to make money by flipping electric cars.

The new law eliminates the 200,000-car trigger for subsidy phaseout, and it also imposes upper limits on the price of cars that qualify — $55,000 for sedans and wagons, $80,000 for SUVs. An SUV is what the EPA says it is. For instance, a Honda HR-V is classified as a wagon, while the Subaru Outback is classified as an SUV. The determining factor seems to be ride height. Expect manufacturers to quietly increase the ride height of some vehicles to move them into the SUV category. The law also limits the new tax credit to individuals with an income of $150,000 or less; $300,000 or less for those taxpayers who are married and file a joint tax return.

A Window Of Opportunity

The new rules apply to an electric car purchased or leased after January 1, 2022, but there’s a kicker. Starting January 1, 2023, a whole new set of rules kick in that affect the tax credit in two ways. First, those electric cars will need to be manufactured in North America. Second, the batteries in those cars must contain components or materials sourced from the US or countries the US has a free trade agreement with, or that have been recycled in North America.

Here’s a list of electric cars sold in the US that Consumer Reports says qualify for the federal tax credit today that won’t qualify next year:

• Audi E-Tron
• Fisker Ocean
• Genesis GV60
• Hyundai Ioniq 5
• Hyundai Ioniq 6
• Hyundai Kona Electric
• Hyundai Nexo
• Jaguar I-Pace
• Kia EV6
• Kia Niro Electric
• Lexus RZ
• Mazda MX-30
• Mercedes-Benz EQB
• Nissan Ariya
• Polestar 2
• Subaru Solterra
• Toyota bZ4x
• Toyota Mirai
• Volkswagen ID.4 (only certain models)
• Volvo C40

If you have your heart set on one of the cars on that list, you had best buy it before the end of this year. Also, according to Consumer Reports, here are the cars that will qualify for the new federal tax credit (assuming they do not run afoul of the battery materials sourcing restrictions):

• Cadillac Lyriq (but only if it is classified as an SUV)
• Chevrolet Blazer EV
• Chevrolet Bolt
• Chevrolet Bolt EUV
• Chevrolet Silverado EV (with certain options and trim levels)
• Ford F-150 Lightning (with certain options and trim levels)
• Ford Mustang Mach-E
• Nissan Leaf
• Rivian R1S (with certain options and trim levels)
• Rivian R1T (with certain options and trim levels)
• Tesla Cybertruck (with certain options and trim levels)
• Tesla Model 3 (with certain options and trim levels)
• Tesla Model Y (only if it is classified as an SUV — it appears that it is — and only with certain options and trim levels)
• Volkswagen ID.4 (only 2023+ models made in Tennessee)

Sourcing Battery Materials For Electric Cars

The impetus for the battery materials sourcing requirements takes a little explanation. Ever since Nixon went to China, the US and Europe have been only too glad to let China supply them with low-cost products. It was an article of faith in the neoliberal playbook that has dominated world financial thinking that outsourcing and offshoring were the keys to never-ending profits. But now the bloom is off the globalization rose. In the words of a popular song by Sting, “I will turn your face to alabaster when you’ll find your servant is your master.”

Abigail Wulf, director of the Center for Critical Minerals Strategy at Securing America’s Future Energy (SAFE), told Wards Auto in a recent interview, “While China is not the primary producer of cobalt, nickel and lithium, it is the primary processor of them. The US processes less than 4% of all mineral commodities. Additionally, China produces more than 60% of all (battery) cathodes and 80% of all anodes.”

China currently controls the processing of nearly 60% of the world’s lithium, 35% of nickel, 65% of cobalt, and more than 85% of rare earth elements, Wulf says, adding that the US imports 100% of its annual graphite requirements, and a majority of that comes from China. The chart below from Benchmark Mineral Intelligence has different figures but the same basic story.

Who owns the Earth? The scramble for minerals turns critical – @thetimes ft Benchmark’s @hjesanderson

🌏 China controls the metals that are vital to the modern economy. Is the West’s fightback too late? #EV #Lithium #Cobalt #Nickel #Graphite #Manganese

https://t.co/KMucrZhY6z pic.twitter.com/OVbXoXsEJu

— Simon Moores (@sdmoores) May 1, 2022

In other words, if China decides to turn off the supply chain taps on those critical materials, the US and other nations would be in deep doodoo, especially once the EV market is, say, 70% of the auto market rather than the ~5% it is at in the US today.

Europe and especially Germany decided to mortgage their futures to Russia in exchange for access to cheap methane supplies. Most of the world has similarly turned a blind eye to the potential danger of relying heavily on China for critical materials, and now the chickens are coming home to roost. The problem is only exacerbated by Xi Jinping’s decision to throw all of the toys out of his crib because a US official dared to visit Taiwan.

Insourcing & Onshoring

Now the US has belatedly decided to protect itself from the threat to its economy posed by allowing China to become the elephant in the room. The new manufacturing and battery materials sourcing rules are designed to spur investments in North America, but the timeline will put enormous pressure on all actors. “It’s good that it (the IRA) is focused on building a base of processing and manufacturing here, but at the end of the day it’s going to be really complex to implement and explain to consumers,” Brett Smith, technology director at the Center for Automotive Research in Michigan, tells Consumer Reports.

One potential beneficiary is the battery recycling industry. Battery materials that originally came from China become eligible for the new federal tax incentives if they are reprocessed in North America and used to produce new batteries for electric cars built in North America. The problem is there really aren’t that many batteries available for recycling yet, and there won’t be for years. As Elon Musk recently stated, it might be 12 or even 15+ years before an EV’s battery is ready for its next life. There aren’t many 12-year-old EVs on the road today, or many with batteries prematurely ready for recycling due to being in an accident or such.

Chris Harto, CR’s senior policy analyst for transportation and energy, says the provisions in the IRA might slow EV sales in the short term, but that it’s a “massively positive” benefit for EV adoption as a whole. “Over the longer term automakers will adjust, bring their EV and battery manufacturing supply chains to North America, and ensure that American tax dollars are going to support American jobs,” he says. CleanTechnica also recently published a similar opinion: “The Hardest (& Best) Thing About The US Clean Vehicle Tax Credit.”

“Even though some vehicles that currently qualify will become ineligible, those tax credits were going to run out eventually — and likely pretty quickly for most popular vehicles — so the benefit would have been short lived.” Brett Smith tells Consumer Reports, “Generally, it’s going to be tough to create the processing here and really tough to create the mining here.”

Questions Remain

There are many unanswered questions about how the new tax incentives for electric cars will operate. If you owe less than $7,500 in federal taxes and buy a car that qualifies for the full credit, do you get, a.) the amount of your tax liability? b.) $7,500? c.) bubkes? Frankly, we don’t know the answer. Here is a blurb from Kelley Blue Book that says you’ll get the full amount of the credit no matter what:

“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.”

However, the legislation still hasn’t made it through the House of Representatives and been signed by Joe Biden, so we’ll have to wait for confirmation on all of this until that’s done and the experts decipher the final legalese.

There’s more. Nowhere does the law clarify how all of this applies to Tesla and other companies that sell directly to consumers without a dealer involved. We know there is a new tax credit for used electric cars, but it specifically requires the sale must be made by a licensed dealer. Tesla sells a lot of used cars. Does the credit for used cars apply to Tesla? Inquiring minds want to know. It appears that any company licensed to sell cars in a state is considered a “dealer” in the text of the bill, but we don’t know for sure if that does indeed mean Tesla, Lucid, Rivian, and others who don’t sell through traditional dealerships qualify.

Please note: This article was written on Wednesday, August 10. The IRA has not yet passed the House and has not been signed into law by the president. Any number of changes could take place between now and whenever a final version of the legislation is enacted. If there are errors or omissions in this article, it is probably because accurate information is currently unavailable. When we know more, you’ll know more.