The most important things to know about the Federal Tax Credit

Update: As of August 2022, The Inflation Reduction Act passed by congress raises the Solar Tax Credit to 30% until 2032.

Introduction

For many years, residential solar energy was a luxury reserved for the wealthy and the well to do.  In order to spur the industry,  administrations within the federal government introduced a tax credit to ease the burden on homeowners with the desire to install solar photovoltaic panels on their home.  Several years removed from the creation of the solar tax credit, the barrier to entry is much lower and it has become feasible for many homeowners before the credit is taken into consideration.

How does the federal tax credit work? Are there any conditions you need to meet in order to qualify? What if my state offers a credit on my state taxes, does that lower my federal rebate? Nobody likes talking about taxes, there’s a reason tax professionals are paid so handsomely to take the burden of filing one’s taxes off our hands.  We’ll break it down and answer a few questions to help keep homeowners better informed.

This overview will focus on residential solar installations, some conditions may differ for commercial installations 

Disclaimer: The following is an overview of the federal solar tax credit, this is not professional tax advice or professional financial advice.  Consult a qualified professional prior to making applicable financial decisions or entering into binding contracts. 

History

As is the case with most history of IRS codes, the history of the federal solar tax incentive is quite tedious, therefore it shall be kept brief.  

The Solar ITC (Investment Tax Credit) was enacted in 2006.  Since then it has gone through a series of revisions and extensions.  In 2016, the Solar ITC was 30%, with the intention of being pared back periodically until it is eventually removed. 

In the year 2021 the Solar ITC is 26%. Many online resources indicate the 2021 Solar ITC is 22%, this is likely because prior to late 2020, it was intended to go down to 22%. Due to federal legislation the 2020 Solar ITC rate of 26% was extended through 2022.  

How does it work?

For many states, municipalities and power companies, there are many incentives and tax breaks to incentivize clean energy.  In many cases, they do not affect the amount of the federal tax credit.  You can inquire in your area and make sure you’re maximizing your cash back before redeeming smaller offers. Almost definitely, the Federal ITC will yield the most money back on your new solar power system.

A tax credit represents a dollar for dollar decrease in your tax liability.  This differs from a tax deduction which decreases the amount of taxable income which determines how much you owe in taxes.  

For our purposes here, let’s take our fictional homeowner, Stan and his wife Jan who have chosen to install solar on their home.  The cost of their installation is $32,000, which is fairly average for some areas.  This cost includes almost every aspect of the process.  It includes all equipment including, all labor costs associated with installing the system and the costs of permits for the installation.  All of these costs qualify for the tax credit, the entire $32,000 will be considered part of the installation as far as their taxes are concerned.  

Stan and Jan’s system is being installed in 2021, so they qualify for the 26% tax credit.  From here it is just simple math:

Cost of system X tax credit amount = Size of tax credit

$32,000      X        26%               =  $8,320

Stan and Jan are now entitled to a $8,320 decrease in their tax liability.  If that exceeds the amount they owe in taxes, it will roll over to the following year until it is exhausted.  

So if they would owe $6000 in taxes for 2021, their tax liability would be reduced to $0 then their liability would be decreased by another $2,320 for 2022. 

What’s the Catch?

In this case, there is no glaring catch other than a few key conditions: 

You must own the solar power system, either through cash or financing, in order to claim the credit.  Homeowner’s who lease their panels or sign a Power Purchase Agreement, or PPA, are not eligible.  

Another key qualifier for the Solar ITC is taxable income. Individuals or couples filing jointly who do not have taxable income are ineligible for the Solar ITC. Unique situations can create circumstances in which the IRS deems nontaxable income such as those receiving disabled veteran benefits. 

As stated above, consult with a qualified tax professional if you have questions about your individual situation.  

How long does it last?

In the words of Robert Frost, nothing gold can stay.  The same applies to tax incentives worth thousands of dollars.  The federal solar tax credit used to be 30% as recently as 2019, 26% in 2020-2022 and will be reduced to 22% in 2023.  After that, it will be eliminated completely.  As just about anyone in the solar industry will tell you, there is no better time to investigate solar than right now! 

Making the switch to solar has been a great decision for millions of homeowners.  Residential solar power has created incredible savings and helped reduce their carbon footprint.  It may be of incredible value, even without the federal tax credit.  Homeowners considering solar should be informed of all of their options for rewards and incentives including from state and local entities.

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