How Does the Electric Car Tax Credit Work?

America’s electric car revolution is underway, with sales boosted partly by federal, state, local and utility incentives in an effort to get more EVs on the road. Since 2008, the federal government has offered federal tax credits of up to $7,500 when you purchase an electric vehicle (EV) or plug-in hybrid electric vehicle (PHEV).

With the Inflation Reduction Act’s 2022 passage through Congress and presidential approval, the current federal electric car tax credit system has been overhauled. The changes will allow the buyers of a few electric cars currently ineligible for the tax credit to receive them. However, they make it so buyers of many others are now unable to get credit. For the first time, there is a federal EV tax credit for buyers of used electric vehicles.

The goal of the new incentive program is to urge consumers to consider electric vehicles, while at the same time encouraging the development of a North American supply chain for EV batteries and the vehicles they go in.

While the old system was simple – if you bought a qualifying EV or PHEV from a company that had sold fewer than 200,000 EVs or PHEVs, you would get up to a $7,500 credit – the new system is wildly complex. The new rules include income caps on buyers who can earn credits, price caps on eligible vehicles, a requirement that the EV be manufactured in North America and regulations about where the components of the batteries come from. Customers of automakers that exceeded the limits of the old program may now be once again eligible to get the credit on a new car purchase. Starting in 2024, you’ll receive the cash when you buy your electric car, not when you file your taxes.

In this guide, we’ll help you determine whether you and the car you buy are eligible to receive the new Federal Electric Car Tax Credit of up to $7,500. Since the rulemaking for the act continues to evolve, it’s critical you check with a tax professional before you assume you can get a tax credit.

From August 16, 2022, forward, the rules outlined in the Inflation Reduction Act will apply to new electric car purchases. There is an exception to some of the rules if you had a binding purchase contract before the law was signed.

The new EV incentives provide a tax credit of up to $7,500 for a qualifying new car and $4,000 if you purchase a qualifying used EV. The old program excluded used car buyers altogether. Until the end of 2023, any tax credits you qualify to receive will only be enjoyed when you file your next year’s taxes. Starting in 2024, the credits can be applied when you buy the car, effectively lowering the vehicle’s price and lessening the amount you’ll have to finance.

Note that the new legislation has not affected the state, local and utility incentives you may receive on the purchase of an EV.

New car buyers who meet the law’s income restrictions and who buy new vehicles that meet the act’s numerous limitations can receive:

The new program aims to solve some issues with the old program, such as placing limits on wealthier buyers who would likely buy an EV without the credit. The act goes on to ensure the vehicles and their components are built in North America, with materials sourced from places enjoying free trade agreements with the U.S. and not on the federal government’s list of restricted countries. Many of the restrictions are the result of last-minute politicking to ensure the bill’s passage.

The Inflation Reduction Act places strict limits on who qualifies to get a tax credit. Single filers must have a modified adjusted gross income (MAGI) of $150,000 or less. Joint filers have a $300,000 limit, while heads of household must have a MAGI of $225,000 or less.

The thinking with this rule is that buyers with incomes above the threshold have the means to buy an EV regardless of the tax credit, so no incentive is necessary.

The way that legislation was crafted has created a multitude of restrictions that limit the electric vehicle models that will qualify for all or part of the credit. Early analysis of the statute indicates that few EVs will be eligible for credits once the rulemaking by the federal government is complete. As the North American EV production, battery assembly, and raw material mining industries ramp up, models will begin to qualify again.

According to the Treasury Department, the final rulemaking about the critical mineral sourcing requirement in the law will not be complete until sometime in March 2023. Other critical attributes of the act that were scheduled to start on January 1, 2023, will go into effect, as planned.

The amount of the EV credit no longer depends on battery size. All EVs, PHEVs and other “clean vehicles” such as hydrogen fuel cell vehicles that meet the government’s array of restrictions will qualify.

To qualify for the new Federal Electric Car Tax Credit, the price of a new car must be $55,000 or less. The purchase price of a new truck, van or SUV must be $80,000 or less.

Currently, a few foreign nameplate automakers build EVs in North America. The Nissan Leaf is made in Symrna, Tennessee, and the Volvo S60 Recharge is produced in South Carolina. Production of the Volkswagen ID.4 was started outside of the U.S. but has recently moved to Chattanooga, Tennessee. The IRS will rely on a car’s vehicle identification number, or VIN, to decide its country of origin.

Losing out because of the restriction will be Kia, Hyundai, Genesis, Audi, Porsche, Subaru and other automakers that build their EVs solely outside North America. For those companies that make electric vehicles outside of the U.S., the new credit program is like the Chicken Tax of the 1960s, which still limits the importation of pickups and cargo vans into the United States. Since the law’s passage, several foreign-nameplate automakers have announced plans to develop or accelerate North American EV production.

The European Union and Korea have indicated plans to challenge the new rules, which they feel break international trade agreements.

Great, you think, in 2023 I can get a full $7,500 back on any North American-made EV I decide to buy, as long as I meet the income limits and it’s not too expensive.

Starting in 2023, each half of the credit (up to $3,750) you can receive will depend on two other factors: Where the battery components are made and where the raw materials used in the production of the battery come from. We’ll start with the battery component manufacturing.

In 2023, 50% of the EV battery’s components must come from the U.S. or another country that has a free-trade agreement with the United States. In 2024 and 2025, that percentage goes to 60%. It’s 70% in 2026, climbing to 80% in 2027 and 90% in 2028. By 2029, it has to be 100% U.S.-made (or made in a free-trade agreement country).

The most challenging hurdle for EVs to clear will be a requirement that the raw materials used in the battery be recycled or sourced in the U.S. or a country that has a U.S. free-trade agreement. In 2023, 40% has to meet the conditions, climbing steadily each year to 80% in 2027.

Additionally, none of the battery components can come from a specifically restricted country. The list currently includes Russia, China, North Korea and Iran.

No electric vehicles made today can meet both the production and material sourcing requirements. Because of that, no vehicles will be able to take advantage of the full tax credit.

Over the next few years, automakers will struggle to develop supply chains that meet the strict sourcing requirements. That means it’s likely that no EVs sold in at least the next couple of years will qualify for the full $7,500 incentive. Over the long haul, however, the restrictions are designed to produce a robust American supply base that’s not reliant on foreign sources.

During the first few months of 2023, however, there is a small opening where vehicles that won’t qualify for the credit later in the year can still receive it. That’s because the U.S. Treasury Department hasn’t completed its rulemaking on the raw materials sourcing part of the law, and can’t enforce it. Until it finalizes the rules, vehicles that won’t pass later in the year can sneak through the temporary loophole.

After January 1, 2023, North American-made Tesla, General Motors and Toyota vehicles will once again qualify for the federal tax credit program, assuming they meet its other criteria. The three company’s vehicles had previously met the old program’s 200,000-vehicle limit and were then excluded from the program. That limit is dropped once the calendar flips to 2023.

For the first time, a federal tax credit is available to buyers of pre-owned vehicles, though it comes with a slew of restrictions.

In addition to the limits on the vehicle, purchasers must meet stringent income limits. If you’re a joint filer, your modified adjusted gross income cannot exceed $150,000 in the year you purchase the vehicle. Those filing as a head of household have a limit of $112,500, while single filers cannot exceed a $75,000 income limit.

If you purchased a new vehicle that qualifies under the original Federal Electric Vehicle Tax Credit program before the new bill was signed into law on August 16, the old rules apply to the purchase, and you can claim whatever credit you qualified for under the old rules.

Under the old rules any EVs produced by a manufacturer that had not sold 200,000 or more fully electric or plug-in hybrids could qualify for a $7,500 tax credit that would be used to reduce any taxes the buyer would owe for that tax year.

There was no program for used vehicles under the old bill, so you would not receive a tax credit under the old rules for the purchase of a used electric car.

The IRS has determined that if you had a “written binding contract” in place before the president signed the bill into law on August 16, 2022, the rules of the old program apply, whether or not the vehicle is in your possession. The vehicle purchase is not subject to income, price or origination limits.

A signed purchase agreement is more than just a refundable deposit made on an EV maker’s website. In most states, a significant non-refundable deposit or down payment is required for the contract to be considered binding.

If you purchased a new EV between August 16 and the end of 2022, you may qualify for the full $7,500 tax credit. However, any EV purchased is subject to the North American production rule (but not the battery production or material sourcing rules).

Additionally, the old program’s 200,000-unit rule still applies, meaning that Tesla, GM and Toyota buyers can’t get any federal tax credit if they purchased an EV or PHEV in 2022.

Determining whether a vehicle qualifies for a tax credit is only one of the questions you’ll want an answer to before you buy or lease your next car. Our new car rankings and reviews are designed to answer the questions shoppers have when they’re looking for a new ride.

The next step is finding a great price on your purchase or lease. An easy way to save money is the U.S. News Best Price Program. It connects shoppers with local dealers, offering significant savings with pre-negotiated prices, home delivery, and online sales options.

Another way to save some cash is with an automaker’s special new car deal. Our new car purchase deals page is the place to find buying incentives with low-cost financing or cash back. Our lease deals page showcases lease offers with low monthly payments and little due at signing.