3 Ways the Inflation Reduction Act Could Impact Your Taxes
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By now, you’ve probably heard about the Inflation Reduction Act President Biden signed into law in mid-August. On the surface, it sounds like a good thing. Who wouldn’t want to reduce the sky-high inflation we’ve all been dealing with this year? But, as always, there’s a little more to it.
Let’s go over the goals of the Inflation Reduction Act and how some of its tax changes could impact taxpayers like yourself in 2022 and beyond.
What does the Inflation Reduction Act include?
The Inflation Reduction Act (IRA) covers a lot of ground — ambitious investments in clean energy to help combat climate change, prescription drug pricing reform, and even tax increases on large corporations.
We’re going to narrow our focus to three main ways the IRA is likely to impact individual taxpayers or small businesses:
- Changes to clean energy tax incentives
- Large IRS funding increases
- Extension of the Affordable Care Act (ACA) subsidy program
Inflation Reduction Act & its effect on your taxes
1. Clean energy tax credits
The Inflation Reduction Act offers homeowners many tax incentives and rebates for going green. If you’ve been thinking about making clean energy updates to your home, these rebates could help you save a lot of money.
Energy Efficient Home Improvement Credit
This new tax credit is a revamp of an old tax credit that expired at the end of 2021.
Previously, the credit allowed you to claim 10 percent of the cost of installing specific energy-efficient improvements in your home, including windows, doors, skylights, insulation, roofing, and more. The old credit also allowed you to claim 100 percent of the costs of installing residential energy property like heat pumps, water heaters, central AC systems, etc.
But there was a catch — a lifetime credit limit of $500 and other individual credit limits for certain types of equipment. For example, a $200 credit limit was allotted for installing new windows.
If you intend to claim this tax credit for tax year 2022, the old tax credit rules still apply.
However, beginning Jan. 1, 2023, you will be able to use this tax credit to claim 30 percent of the cost of eligible energy-efficient home improvements, with a $1,200 annual limit (with one exception we note in the list below).
Other individual credit limits beginning in 2023 include:
- $250 limit for one exterior door and a $500 limit if you decide to upgrade all your exterior doors
- $600 limit for exterior windows and skylights; central air conditioners; electric panels (as well as certain related equipment); and natural gas, propane, or oil furnaces or hot water boilers
- $150 limit for home energy audits
- $2,000 limit for electric or natural gas heat pumps, water heaters, or biomass stoves and boilers
Starting in 2025, you will need to include a product identification number from the equipment manufacturer on your tax return to claim the tax credit.
For more information on what types of equipment are covered, check out ENERGY STAR’s website.
Residential Clean Energy Credit
Another credit expanded and enhanced by the IRA is the Residential Clean Energy Credit, a tax break for purchasing eligible solar property.
Here’s what’s changing:
- The IRA restored the credit rate to 30 percent of the cost of installing qualifying clean-energy systems (solar, wind, geothermal heat pumps, fuel cells, etc.) to produce electricity or regulate your home’s temperature. The credit rate had previously dropped to 26 percent in 2020 and was set to expire in 2024.
- You can now claim the Residential Clean Energy Credit through Dec. 31, 2034. The 30 percent credit rate is available through 2032, then reduces to 26 percent in 2033 and 22 percent in 2034.
- Biomass furnaces and water heaters will only be eligible for the credit through the end of 2022. Beginning in 2023, qualified battery storage technology with a capacity of at least 3 kilowatt hours (kWh) becomes eligible. Solar, fuel cells, or wind energy equipment used to generate electricity will remain eligible through 2034, as well as geothermal heat pump equipment used to regulate your home’s temperature.
Electric vehicle tax credits
If you’ve been considering buying an electric vehicle (EV), you’re in luck! The IRA extended the existing federal Electric Vehicle tax credit for 10 years to help reduce emissions. It’s now available through 2032 and comes with numerous changes.
We’ve listed the short version below, but you can learn about the EV tax credit changes in more detail in this article.
- The credit now applies to any “clean vehicle,” including hydrogen fuel cell cars.
- Used EVs placed in service after 2022 can now qualify for the credit, while only new EV purchases were previously eligible.
- For vehicles placed in service after Dec. 31, 2023, you can take the credit as a discount at the time of purchase rather than waiting until filing your federal income tax return (potentially more beneficial, allowing you to claim the entire credit amount as a discount without it being limited to your tax liability).
- New limitations require the vehicle’s final assembly to be completed in North America to qualify.
- The IRA also imposes new income limits for buyers to qualify for the federal EV credit (these income limits differ depending on if you are buying a new or used clean energy vehicle).
- There are new retail sale price limits vehicles must meet to qualify.
- The IRA removed the 200,000-car sale cap, meaning some vehicles that were previously ineligible due to this cap could become eligible again.
2. Increases in IRS funding and tax enforcement
If you’ve been keeping up with news about the Inflation Reduction Act, you may have also heard about the $80 billion going to the IRS over the next 10 years.
How will the IRS use this funding?
The IRS has been severely underfunded and understaffed for a while, and the pandemic only worsened matters. As of June 2022, the tax agency still had a backlog of 11 million individual tax returns waiting to be processed — twice as many as an average year.
The new funding provided by the Inflation Reduction Act will allow the IRS to hire more employees, modernize its outdated IT systems, and resume proper auditing rates, which have been down by over 50 percent.
What’s my audit risk?
Did alarm bells start ringing in your head with the thought of increased audits? Don’t worry — this will not likely affect poor or middle-class Americans.
Treasury Secretary Janet Yellen stated that the IRS should not increase audit rates on individuals or small businesses earning less than $400,000 per year. Instead, the agency will focus on “high-end noncompliance,” like large corporations and individuals with complex taxes and high net worth. Hardworking low- and middle-income households should not be a target.
In fact, households and businesses under the $400,000 threshold should be less likely to be audited, thanks to expected information technology improvements and more robust customer service, making the kinds of confusion that can lead to audits less likely.
3. Extension of the ACA health care subsidy program
Lastly, the IRA has extended the enhanced Affordable Care Act (ACA) subsidy program through 2025.
This program offers federal subsidies to low- and middle-income households in the form of premium tax credits (PCTs). The PCT is a refundable tax credit designed to help you afford health insurance coverage for your family. Since it is refundable, you can still claim the full credit even if it’s greater than your tax liability.
The American Rescue Plan (passed in March 2021) expanded the ACA program availability by temporarily allowing more people to qualify for the premium tax credit. If you qualify, you could also get a larger credit as well. These eligibility changes were set to expire at the end of 2022 but have now been extended for three more years:
- You can claim the PCT if your household income exceeds 400 percent of the poverty line and you meet all other qualifications.
- You are eligible to claim the credit if your cost of health insurance premiums exceeds 0-8.5 percent of your household taxable income (the percentage rate is determined by your household income — the lower your income, the lower your percentage rate, and the larger your credit).
The enhanced ACA extension means nothing has changed from tax year 2021, and the same provisions will remain in effect until Dec. 31, 2025.