U.S. Solar Energy Tax Incentives

Savings with Solar Rebates & Incentives > U.S. Solar Energy Tax Incentives

Savings with Solar Rebates & Incentives

The Residential Clean Energy Credit, previously referred to as the ITC, is a tax credit that provides 30% coverage of the total cost of your solar project, including parts, labor, and other related expenses. This credit has no maximum incentive amount and isn't limited to just solar; it also covers battery storage, wind, geothermal heat pump, and fuel cell installations.

For example, if your overall solar project cost is $25,000, your federal solar tax credit would amount to $7,500. Meanwhile, if you spend $75,000 on a combination of solar and battery storage, your tax credit would be worth $22,500.

To take advantage of this incentive, you must meet two key criteria:

You own the system, either through a cash purchase or a solar loan (financing through a lease or PPA does not qualify for the tax credit).
You have an income tax liability that the credit can reduce.

We will explore the process of claiming your federal solar tax credit shortly. But first, let's review how the federal solar tax credit reached its current 30% rate in 2022.

Timeline of Federal Solar Tax Credit Reductions

Since its introduction in 2005, the solar tax credit has undergone several changes and adopted different names. To keep things straightforward, let's call it the "federal solar tax credit."

The tax credit was last set at 30% in 2019 before decreasing to 26% for the years 2020 through 2022. It was expected to drop further to 22% in 2023 and then expire for residential solar customers in 2024.

However, the Inflation Reduction Act intervened, restoring the incentive to 30% for an additional ten years.

Here's the revised step-down schedule for the federal solar tax credit:

Timeline of Federal Solar Tax Credit Reductions

Since its introduction in 2005, the solar tax credit has undergone several changes and adopted different names. To keep things straightforward, let's call it the "federal solar tax credit."

However, the Inflation Reduction Act intervened, restoring the incentive to 30% for an additional ten years.

Here's the revised step-down schedule for the federal solar tax credit:

solar-tax-credit-before-and-after-inflation-reduction.jpg

The updated schedule reflects a 30% tax credit that remains in effect until it decreases to 26% in 2033 and 22% in 2034. The 30% credit is retroactively applicable to solar and battery projects installed in 2022.

Therefore, if you installed solar energy in 2022 when the tax credit was 26%, you can now claim an additional 4% of the project's costs on your taxes.

Please note that this article is for informational purposes only and should not be taken as tax advice. It's recommended to seek guidance from a licensed tax professional for any questions regarding the Residential Clean Energy Credit.

Comparing the Impact of 26% and 30% Tax Credits: What's the Difference?

The federal solar tax credit is calculated based on the gross cost of your solar system, meaning that the larger your solar installation, the larger the tax credit you can receive. This incentive encourages the adoption of solar energy.

Here's an example showing how the tax credit varies between 2021 and 2022 for a 9 kW solar system costing around $27,000:

In 2021, if you installed and claimed the solar system on your taxes, you would have received a 26% credit, amounting to $7,020.
In 2022, the credit increased to 30%, so if you installed and claimed your system that year, you would receive a credit of $8,100.

This results in a difference of $1,080 in savings, which could cover approximately a year's worth of $90 monthly utility bills.

The Calculation of the Federal Solar Tax Credit

To calculate the value of your solar tax credit, you can use a straightforward equation:

Gross cost of project x 0.30 = tax credit value.

For instance, if your solar project costs $30,000, your tax credit will be worth $9,000 ($30,000 x 0.30 = $9,000).

The gross system cost can include any upgrades needed for the solar installation, such as improvements to your electrical box. It's a good idea to consult your tax advisor to understand how these costs might affect your specific situation.

The solar tax credit offers a dollar-for-dollar reduction on your income tax. This means that the credit directly lowers the amount of tax you owe. Keep in mind that you must file and pay taxes within the same tax year to receive the credit.

Now that we understand how to calculate your solar tax credit, let's discuss the process of claiming it.

Guide to Claiming Your Solar Tax Credit

To apply for the federal solar tax credit, you need to submit IRS Form 5695 for the tax year when your solar project becomes operational, typically confirmed by a city inspector. For instance, if your solar panels receive a city inspection approval on August 14, 2023, you would claim your Residential Clean Energy Credit when filing your 2023 taxes, likely in early 2024. We'll guide you through the process of filing for the federal solar tax credit, but we recommend consulting with a tax professional to ensure you don't overlook any important details.

Guide to Filing for the Federal Solar Tax Credit: Step-by-Step Instructions

Let's explore how you might claim a federal solar tax credit using a hypothetical $30,000 investment in a solar system.

Step 1: Prepare your taxes as usual Start by preparing your tax return the same way you normally would. Calculate your income, list your dependents, and take your usual deductions, such as charitable contributions.

When you reach Line 5 of Schedule 3 (Form 1040), you can claim the solar tax credit. This line is specifically for claiming additional credits and payments, including residential energy credits.

Step 2: Fill out Form 5695

The following modification to Form 5695 illustrates a hypothetical situation involving a $30,000 solar panel purchase. This scenario demonstrates the impact of a 30% tax credit available for solar investments from 2022 to 2032.

Here's an alternative version of the paragraph:

Enter the total cost of your solar installation on Line 1. Multiply the cost by 0.30 on Line 6b to calculate your solar tax credit. For instance, if your installation cost $9,000, your credit would be $2,700.

Transfer this credit to Line 13. To find your tax liability for Line 14, use the Residential Energy Efficient Property Credit Limit Worksheet on Page 4 of the Form 5695 instructions.

If Line 14 exceeds Line 13, you can apply the entire tax credit in the current year—great news!

However, if Line 14 is less than Line 13, you won't be able to use the full tax credit this year, but you can carry the remaining credit forward to next year, as noted in Line 16.

For Line 15, enter the smaller amount between Line 13 and Line 14.

Here’s how that looks on the 2022 form:

In this case, we'll assume the tax credit on Line 13 is less than the liability on Line 14, which allows the full credit to be claimed within one year. This means the federal solar tax credit amount of $9,000 will be entered on Schedule 3 (Form 1040), Line 5.

Step 3: Complete Schedule 3 and Form 1040

After calculating a $9,000 federal solar tax credit using Form 5695 for the purchase of a $30,000 solar system, the next step is to enter the credit amount on Line 5 of Schedule 3 (Form 1040). This line is designated for claiming nonrefundable credits on your federal tax return.

To calculate the final total on Line 8 of Schedule 3, fill out the form completely by including any nonrefundable credits and additional taxes from Part I and Part II. Add up the amounts from these sections to determine the total on Line 8. Once you have the final total, enter it on Line 20 of Form 1040, page 2.

Quick Tip: Remember that Schedule 3 and Form 1040 are separate forms, so keep them organized and ensure the totals are accurate when transferring data between them.

Here's how the 2022 Form 1040 should look with the Residential Energy Credit entered from Schedule 3. Make sure to include the credit amount in the appropriate section on Form 1040 for an accurate tax return.

Once your federal solar tax credit is on your Form 1040, the rest is business as usual!

The federal solar tax credit reduces the total tax Uncle Sam wants to collect for the year, shown in Line 24, and can increase your refund or decrease the total amount you owe after payments and refundable credits.

Managing Excess Solar Tax Credits: Strategies for Lower Tax Liability

As a nonrefundable credit, the solar tax credit can only be applied to your tax liability, meaning it doesn't result in a refund check simply for installing solar panels.

What happens if your tax credit exceeds your tax liability?

If you have a $9,000 solar tax credit and only $5,000 in tax liability, you can use $5,000 of the tax credit in the first year. The remaining $4,000 can be carried over to the next year and used to offset future tax liabilities.

While the IRS hasn't released new rules yet, past regulations allowed the federal solar tax credit to be carried over for as long as the incentive remained active. With the Residential Clean Energy Credit running until 2034, you have ample time to use the credit across multiple tax years if you install solar in 2023.

Still, some scenarios, such as for retirees with low tax liability, might limit your ability to utilize the full credit. This isn't ideal, but remember that solar offers many other advantages beyond the tax credit.

Impact of Solar Loans on Solar Tax Credit Eligibility

There are two types of solar loans concerning the tax credit.

Type 1 offers a consistent monthly payment amount throughout the loan term. These loans assume you will use your tax credit to pay down the loan principal, maintaining the same monthly payment.

If you choose not to apply the tax credit to your loan, a second loan will be initiated for the amount of your tax credit, with the same annual percentage rate (APR).

Type 2 features varying payment amounts: the first year has a higher monthly payment, and subsequent years have lower monthly payments. In this loan type, your payments are calculated based on the full loan amount.

Upon receiving your federal tax credit, you can use it to re-amortize the loan for lower monthly payments or retain the tax credit while maintaining the same payment structure.

Solar.com can guide you in choosing the best solar financing option for your needs.

Effortless Solar Energy Adoption

The updated federal solar tax credit has brought a sense of relief to the solar industry, which was rushing to enroll customers before the previous tax credit stepped down and expired.

With the 30% tax credit now available until 2032, more Americans can access the long-term savings of solar energy. Furthermore, the Inflation Reduction Act has made significant investments in American solar manufacturing, which is expected to lower costs and increase the benefits of adopting solar power.

Given the 30% tax credit, the ideal time to switch to solar was yesterday. The earlier you begin generating your own energy, the sooner you will start saving.