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What Is an Energy Tax Credit?
An energy tax credit is a government-sponsored incentive that reduces the cost for people and businesses to use alternative energy resources. Eligible individuals or entities meeting the criteria are reimbursed for their efforts to make the planet “greener” when paying income taxes, with the credit amount being deducted, dollar for dollar, from the total tax bill.
Several federal energy-related tax incentives are available. Each one carries unique requirements, with some targeted at individual homeowners and others at companies.
Key Takeaways
- An energy tax credit is a government incentive that reduces the cost for people and businesses to use alternative energy resources.
- The credit amount either reduces the total sum owed to the Internal Revenue Service (IRS) or is added to your refund if you are due one.
- There are two major energy tax credits available to homeowners: the Energy Efficient Home Improvement Credit and the Residential Clean Energy Credit.
- The U.S. government also offers various energy-related tax credits to businesses that spend money on reducing energy consumption and pollution.
Understanding Energy Tax Credits
Coming up with ways to improve the quality of the air we breathe is a key priority for most of today’s politicians. Increasing pollution that is contributing to global warming has prompted governments around the world to spend record amounts of money to transition to greener technologies. One goal is to make greener energy solutions more affordable.
A popular method has been to introduce various energy-related tax credits. Rather than give people an immediate discount when purchasing a qualifying product, these credits work by reducing the amount of tax owed. For example, if you buy solar panels for $30,000, you qualify for a 30% tax credit, so you can deduct $9,000 from your tax bill.
The Inflation Reduction Act, a landmark piece of legislation signed into law on Aug. 16, 2022, by President Joe Biden, ordered a major revamp of energy tax credits. Many previous credits have been renamed, improved, and extended, and some new incentives have been added to help people and businesses afford the costs of “going green.”
The Inflation Reduction Act introduced much more generous energy tax credits.
Residential Energy Tax Credits
Several energy-related tax credits are available for 2023, including two major energy tax credits for homeowners: the Energy Efficient Home Improvement Credit and the Residential Clean Energy Credit. You can only use one or the other of these two residential energy tax credits in a tax year, so it’s worth considering your financial situation and preferences when deciding between the two.
Energy Efficient Home Improvement Credit
When the Energy Efficient Home Improvement Credit kicked in on Jan. 1, 2023, it offered homeowners a 30% tax credit to cover some of the cost of eligible home improvements. The maximum limit also increased, to $1,200 (or $2,000 for certain heat pumps, biomass stoves, and boilers), and it now resets every year until 2032, meaning it’s possible to save five figures in total.
Under previous rules, you could get 10% off the costs covered by the Nonbusiness Energy Property Credit. However, the maximum you can get was $500, which was a lifetime limit, not an annual one.
Annual limits for individual types of qualifying alterations were also improved as of 2023. They are:
- Home energy audits: $150
- Exterior door: $250, with a $500 total for all exterior doors
- Exterior windows and skylights, central air conditioners, electric panels and certain related equipment, natural gas, propane, or oil water heaters, natural gas, propane, or oil furnaces or hot water boilers: $600
- Electric or natural gas heat pump water heaters, electric or natural gas heat pumps, and biomass stoves and boilers: $2,000
After 2024, items will need to have a specially generated product identification number to qualify for the Energy Efficient Home Improvement Credit.
Residential Clean Energy Credit
Another credit that the Inflation Reduction Act extended and revamped is the Residential Energy Efficient Property Credit. This particular tax break, now called the Residential Clean Energy Credit, continues to offer help toward the installation cost of solar, wind, geothermal, and biomass renewable energy—but on more generous terms.
Under the old law, the credit was worth 26% of the outlay and dropped to 23% in 2023 before expiring in 2024. With the Inflation Reduction Act, it jumped to 30%, where it is set to remain until 2032 before dropping to 26% in 2033 and then 22% in its final year.
The scope of the credit has also adjusted slightly. From 2023, the new incentive will no longer apply to biomass furnaces and water heaters, but it will cover battery storage technology with a capacity of at least three kilowatt-hours (3kWh).
Homeowners should retain any documentation related to purchases that qualify for energy tax credits in case they are audited by the IRS.
Business Energy Tax Credits
The U.S. government also offers various energy-related tax credits to businesses. In many cases, companies that spend money on reducing energy consumption and pollution can get some of their investment returned.
Examples include the production tax credit (PTC) and investment tax credit (ITC), which allow taxpayers to deduct a percentage of the cost of installing a renewable energy system, and the 179D Commercial Buildings Energy-Efficiency Tax Deduction, which enables building owners to claim a tax deduction for installing energy-efficient qualifying systems that lower energy consumption.
Manufacturers of components that reduce carbon emissions, such as solar and wind energy, inverters, and batteries, are also rewarded with tax discounts.
Energy-Related Vehicle Tax Credits
Owners of clean vehicles are also eligible for some perks, courtesy of the Inflation Reduction Act. They include:
- Clean vehicle credits: You may qualify for a tax credit of up to $7,500 if you buy an electric vehicle (EV) or fuel cell vehicle (FCV). Vehicles purchased after April 18, 2023, must meet battery component requirements and critical mineral requirements. If you bought a clean vehicle before that date, you can still claim a tax credit for up to $7,500, starting with a base amount of $2,500 and additional credits based on battery capacity.
- Alternative fuel vehicle refueling property credit: Individuals and businesses that install a refueling property placed into service in that tax year may qualify for 6% to 30% of the cost, with a $100,000 cap.
Investopedia's Tax Savings Guide can help you maximize your tax credits, deductions, and savings. Order yours today.
Other Ways to Save
In addition to federal tax breaks, taxpayers may want to check available rebates for energy-efficient purchases. The Inflation Reduction Act established two rebate programs that are predominantly designed to help low- and middle-income families. Moreover, many appliances, building products, electronics, heating and cooling equipment, and water heaters come with rebates through local utility companies.
Some rebates are available immediately after purchase or following installation. Typically, the total rebate amount depends on the product. North Carolina State University’s Database of State Incentives for Renewables and Efficiency (DSIRE), recommended by the U.S. Department of Energy, offers a collection of both federal and state incentives.
How Do Tax Credits Work?
Tax credits reduce the amount of income tax you owe. You get the full amount of money you were promised when you pay your taxes. For example, if you have a tax credit of $1,000, you would owe $1,000 less in income tax to the IRS (or you would have $1,000 added to your refund if you are due one).
Can I Claim New Windows on My Taxes?
Yes, provided that they meet the requirements. In 2023, you may be entitled to a tax credit covering 30% of the cost of installing energy-efficient windows, up to a maximum of $600 per year.
What Documentation Do I Need to Submit to Receive Energy Tax Credits?
You don’t generally need to supply any documentation with your tax returns. All that’s usually required is that you truthfully answer the questions you’re asked on the forms. That doesn’t mean you should throw everything out, though. It’s advisable to keep hold of documentation related to the purchase of something for which you requested a tax break. The IRS may one day want proof of what you declared, and it’s much easier to prove that with all the original documentation still in your possession.
The Bottom Line
The U.S. government, as evident in the Inflation Reduction Act, is eager to get people to go green. Never before has so much money been available to help individuals and businesses make the jump, and it would be foolish not to take advantage in some way if you have the financial means to do so.
If upfront costs are what have held people and businesses back from investing in green technologies, then energy credits should help make these changes happen—and sooner than they might otherwise. With the government’s help, the savings can be considerable.
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