Solar Tax Credit

The federal solar tax credit is an ITC, or investment tax credit. That essentially means it's a financial incentive designed to encourage investment in a cause that the government wishes to support. The Inflation Reduction Act, enacted by President Joe Biden in 2022, extended solar tax benefits until 2034.

The program's formal name is the home clean energy tax credit, despite the fact that it is frequently referred to as the solar tax credit alone. The credit can be used to cover installation and equipment costs, but it does not cover structural work performed just to support panels. In some circumstances, state incentives and utility-funded renewable energy programmes can be combined with the solar tax credit.

Understanding Solar Tax Credits

The federal and state governments may grant tax breaks to encourage certain acts that benefit the economy, the environment, or anything else they deem important.

For instance, there is a tax credit available that encourages people to install solar panels for their homes. Adoption, education, and other expenses are all partially covered by other tax credits.

Because tax credits reduce the amount of taxes owed dollar for dollar, they are preferable to tax deductions. Even while a deduction lowers the overall tax obligation, it only does so up to the level of the individual's marginal tax rate.

A person in a 22% tax bracket, for instance, would save $0.22 for each dollar of marginal tax that was subtracted. However, a credit would eliminate the tax obligation entirely.

How Solar Tax Credit works

Despite being generous, this federal incentive won't put money in your pocket. Instead, it will lower your federal tax obligation.

For instance, if you put in a $15,000 solar array, you'd be eligible for a $4,500 federal tax credit. This would result in a $4,500 reduction in your tax obligation the following year. (This is distinct from a traditional tax deduction, which reduces your overall taxable income and may lead to a smaller tax bill.)

The IRS states that if the credit you qualify for is greater than the amount of taxes you initially owe, "you can carry forward any excess unused credit and apply it to reduce the tax you owe in future years."

Benefits of Solar Tax Credit

Nonprofits and local governments are two examples of organizations that are eligible to benefit from the tax credits. They can do so either directly or through transferring credit.

Direct pay option:

The IRS will return tax credits for projects that are put into operation after 2022 to tax-exempt organizations (i.e. non-profits), states, municipalities, the Tennessee Valley Authority, Indian Tribal governments, any Alaskan Native Corporation, and rural electric cooperatives.

Domestic content requirements must be met for projects with construction starting in 2024 that are 1 MW or more, or they risk only receiving a 90% tax credit refund. For projects that begin development in 2025 and after, the percentage decreases to 85% and 0%, respectively. Where the IRS requests and makes excess payments, a 20% penalty may be imposed.

In order to qualify for the ITC and PTC, an individual or for-profit organization must owe federal taxes in that year. As a result, the credits are not refundable (though they may be carried forward).

Transfer of credit:

The tax credits for a particular year may be sold in full or in part to another eligible taxpayer who is not linked to the seller. Eligible taxpayers who are not eligible for direct payment may do so. The purchase of the tax credit must be made in cash, and payments are not deducted from the tax credit buyer's income for federal tax purposes because they are not deemed to be gross income. If too many credits are claimed, a 20% penalty may be imposed.

Key Takeaways

A solar tax credit provided by the American government allows you to recover up to 30% of the cost of constructing a solar power system.

Other forms of renewable energy projects carried out by homeowners are also covered by the domestic clean energy credit, subject to certain restrictions.

It is necessary to complete IRS Form 5695 in order to claim the solar tax credit.

Even though it might result in a lower credit, you can still claim the tax credit if you receive other clean energy incentives for the same project.