Jump-Starting Clean Vehicles With The New Tax Credit

With the passage of the Inflation Reduction Act of 2022 (H.R. 5376), Congress created a credit for clean vehicle technology for which few, if any, vehicles on the market qualify. That has troubled the industry, but if a credit is intended to encourage the development and adoption of a new technology so that it can eventually supplant older, established technology, changing the requirements as the technology advances and gains acceptance is necessary. The bill does that in novel ways, and not solely to raise the bar on environmental impact mitigation.

The headline credit change is in section 30D, the current credit for electric vehicles, but there are also new incentives for used EVs, commercial vehicles, and alternative fuel refueling property. The credits are far from the largest expenditures in the Inflation Reduction Act, but they’re significant. The revamped clean vehicle credit (formerly the credit for plug-in electric vehicles) is estimated to cost $7.5 billion over 10 years; the new credit for the purchase of a previously owned qualified plug-in EV is $1.3 billion; the credit for qualified commercial clean vehicles is $3.6 billion; and the credit for alternative fuel refueling property is $1.7 billion, according to Joint Committee on Taxation estimates.

The EV credit has long had an image problem, thanks primarily to Elon Musk, who made EVs luxury items. The early adopters of the Leaf were chiefly making an environmental statement, but a Tesla is often a suburban status symbol. Handing out $7,500 subsidies for vehicles that cost in the ballpark of — and sometimes much more than — the average U.S. annual household income has always been a bit injudicious.

So the Inflation Reduction Act proposes a contraction of the credit in important respects, and that has carmakers worried. First limiting and then eliminating incentives for the production of a beneficial new technology as it approaches commercial viability, and then once it has achieved that, is the crux of the argument for subsidizing new tech that reduces a negative externality. But things haven’t quite worked out that way for the commercialization of alternatives to combustion engine vehicles.

The alternative fuel vehicle credit of the early 2000s gave taxpayers a deduction of up to $2,000 for an alternative fuel vehicle or a hybrid. In the Energy Policy Act of 2005, the deduction was switched to a credit of up to $4,000. In 2009 Congress created the credit for EVs and plug-in hybrids and made it $7,500 until a manufacturer had sold 200,000 vehicles, with a phaseout thereafter. The phaseout wasn’t meant to be the beginning of negotiations on an extension. It was meant to be the end, the rough point at which alternatives to the combustion engine had reached commercial viability.

Big Changes Ahead

Accordingly, section 30D gets a major face-lift under the Inflation Reduction Act, and the priorities are no longer only to help more environmentally friendly technology compete, but also to develop the manufacturing capabilities for it in the United States. Instead of defining the term “new qualified plug-in electric drive motor vehicle,” subsection (d) defines “new clean vehicle.” New income limitations determine who can take the credit, with no credit available to taxpayers with modified adjusted gross income for the tax year in which the purchase is made or the preceding tax year above $300,000 for joint filers, $225,000 for heads of household, or $150,000 for single filers. The credit applies only to vehicles with a manufacturer’s suggested retail price below $80,000 for vans, sport utility vehicles, and pickup trucks, or $55,000 for other vehicles. The IRS and Treasury will determine where a given model fits into that schema.

The maximum price differential between vans, SUVs, and pickup trucks and the “other” category is large, and perhaps a reflection of the lack of electric options for bigger vehicles on the market.

But that situation is about to change — for example, General Motors Co. is getting ready to deliver Hummer EVs with an MSRP of over $100,000, Ford already has the Mustang Mach-E SUV, and Chevrolet will debut a midsize SUV next year, so setting the price point $25,000 higher for bigger vehicles is belated, even taking into account their increased materials costs. For example, the difference between the MSRP of the Honda Odyssey van and the Honda Civic sedan is only about $10,000 to $14,000 for the LX and Touring trims of those vehicles.

The minimum battery capacity requirement is increasing from 4 to 7 kilowatt-hours. That’s a surprisingly modest change in light of the original Nissan Leaf’s battery capacity over 20 kWh, and new models from various manufacturers are pushing into the hundreds of kilowatt-hours. Maybe the credit drafters thought that raising this requirement was unimportant because of the obvious market incentive to increase capacity.

The chief concerns of the auto industry are the stringent new critical mineral and battery component requirements, which limit the credit’s availability. Instead of the limitation on the number of new vehicles in current subsection 30D(e), the Inflation Reduction Act introduces those new requirements.

Critical minerals are defined by cross-reference to section 45X(c)(6). New section 30D(e) requires that the percentage of the value of the applicable critical minerals extracted or processed in the United States — or any country with which it has a free trade agreement — or recycled in North America in the battery of an EV be equal to or greater than the applicable percentage. The applicable percentage is defined as 40 percent for vehicles placed in service after Treasury issues guidance and before January 1, 2024; 50 percent for vehicles placed in service in 2024; 60 percent for vehicles in 2025; 70 percent for vehicles in 2026; and 80 percent for vehicles after December 31, 2026. Manufacturers must certify that their batteries meet the applicable percentage, which will require the IRS to develop another certification process.

The battery components requirement in section 30D(e)(2) is similar. The percentage of the value of the components in the battery that are manufactured or assembled in North America must be equal to or greater than the applicable percentage. That starts at 50 percent before January 1, 2024, increases to 60 percent for 2024 and 2025, and then begins a 10 percent climb every year until it hits 100 percent after December 31, 2028. Like with the critical minerals change, manufacturers must certify this requirement.

The IRS and Treasury received an early holiday gift. They now have a December 31 statutory deadline for proposed guidance under section 30D(e). It will include requirements for recordkeeping or information reporting. The likelihood of proposed forms accompanying that guidance in December seems slim.

Section 30D(d) will have an added subsection (7) that expressly excludes vehicles whose batteries include any critical minerals that were extracted, processed, or recycled by a “foreign entity of concern,” a term that comes from the Infrastructure Investment and Jobs Act (P.L. 117-58). The cross-referenced code section in title 42 makes clear the purposes of the changes: to “ensure that the United States has a viable battery materials processing industry to supply the North American battery supply chain,” expand U.S. battery manufacturing capabilities, enhance national security, and boost domestic mining and processing capacity (42 U.S.C. section 18741(b)(2)). Given that focus in the Infrastructure Act, it’s unsurprising that the tax code is taking a complementary direction.

Also to aid the domestic industry, final assembly must occur within North America, according to new section 30D(d)(1)(G). Final assembly entails a plant, factory, or “other place from which the vehicle is delivered to a dealer” and the process of producing a new clean vehicle with all the component parts required for operation.

The potential trade debacle that the Build Back Better Act’s version of the EV credit threatened to trigger is at least partly averted by the new proposal’s expansion into North America of the prior bill’s domestic assembly and content requirements. (Prior coverage: Tax Notes Federal, Dec. 20, 2021, p. 1609.) The EU has already started to grouse about protectionism even though the concerns of Canada and Mexico have likely been mitigated.

The new term “qualified manufacturer” includes any manufacturer, as long as it meets the definition in Environmental Protection Agency regulations for administration of Title II of the Clean Air Act. That definition includes anyone engaged in manufacturing or assembling new vehicles, as well as importers. They also must have an agreement with Treasury under which they provide periodic written reports providing vehicle identification numbers “and such other information related to each vehicle manufactured by such manufacturer as the Secretary may require.” The IRS will need some time to design or adapt a form to be used for those reports. For each sale, the seller must send a report to both the taxpayer-purchaser and the IRS including the name and identification of the taxpayer, the VIN, the vehicle’s battery capacity, verification that the original use commences with the taxpayer, and the maximum credit allowable to the taxpayer under section 30D.

The fuel cell motor vehicle credit in section 30B expired at the end of last year. The addition of subsection 30D(d)(6) gives fuel cell vehicles a renewed credit, which adds new qualified fuel cell motor vehicles to the definition of new clean vehicle. The definition of qualified fuel cell motor vehicle will remain the same as in section 30B(b)(3).

The changes that make up the clean vehicle credit are substantial and mark a departure from both the existing plug-in EV credit and the proposals entertained in connection with last year’s attempt to pass a reconciliation bill. The tightened requirements could result, at least in the short term, in a reduction in the subsidy’s uptake. But the changes indicate other priorities as continued justification for the credit, and until those are met to Congress’s satisfaction, they unexpectedly renew the credit’s purpose.