How does the Federal Solar Tax Credit Work?

What is a Solar Investment Tax Credit?

This is a tax-linked monetary incentive offered to taxpayers allowing individuals and businesses to deduct a specific sum or percentage of an investment expenditure from their tax liability. Unlike other deductions allowed on the taxable income, the tax credit is directly reduced from the tax owed.

For the first time, the investment tax credit was introduced to American taxpayers in 1962 as a measure to protect local businesses from foreign competition. The purpose and objectives of the federal tax credit have changed over the years. Today it is used as a vehicle to promote green energy.

With the Energy Policy Act of 2005, the solar investment tax credit was introduced for residential and commercial solar installations. It applied to solar projects put in place between 1 January 2006 and 31 December 2007. The federal tax credit was set at 30% of the project cost. 

This was set to expire by the end of 2007 but the way it boosted solar installations, Congress decided to extend it. ITC validity was extended multiple times at the same rate until the end of 2019. From 1 January 2020, the rate was reduced to 26%. It remains 26% till 31 December 2022. In 2023, the ITC rate will further reduce to 22%. 

There is no guarantee of an extension after 2024 for residential solar installations, though commercial installations will be eligible for a 10% tax credit.

Here is the timeline for the federal solar tax credit.

• 2006-19 – 30%
• 2020-22 – 26%
• 2023 – 22%
• 2024 – nil for residential and 10% for commercial

How to avail of the solar panel tax credit?

If the solar installation is an outright purchase, you are eligible for the federal tax credit. Even if you don’t have enough tax liability to avail of the full amount of the tax credit, you are allowed to “roll over” the remainder of the credit amount to future years. The only catch is that the federal tax credit scheme should be active.

On the other hand, if you are opting for a lease agreement or power purchase agreement (PPA) with a solar installer, you are not eligible for this tax credit. The reason is simple. In these instances, you do not own the system. 

The good news is that ITC is available to all taxpayers irrespective of their income. There is no ceiling on the income.

What expenditures are covered by the federal tax credit?

Homeowners are allowed to claim expenses incurred towards the purchase of these equipment and services related to the solar energy system.

• Solar panels and related equipment including mounting hardware
• Solar batteries if included
• Sales tax and shipping charges
• Solar consultation and inspection fees
• Installation charges
• Developer and engineer fees
• Electrician fees
• Tools and devices rented or purchased for installation
• Electrical and metalwork paraphernalia like wires, screws, nails, and bolts
• Expenditure on construction aids like scaffolding and man-lifts
• Permitting fees and service charges

How long can you claim the federal tax credit?

The year you make the solar purchase, you can claim the solar panel tax credit if you owe any federal tax. Unfortunately, the tax credit is just that, a tax credit. It is not a tax rebate or a refundable benefit. This means if you don’t owe taxes, you cannot claim solar tax credit.

However, all is not lost for those with no tax liability. As per Section-48 of the Internal Revenue Code, you are allowed to carry forward the tax credit up to 5 years, as long as the ITC is active. 

You are also allowed to claim a partial tax credit and carry forward the rest to future years. For instance, if you have a $10,000 tax credit on account of solar installation this year and your tax liability for this year is $3,000, you can use up just this much amount from the tax credit and carry forward the remaining $7,000 to the next year. The next year again, you can claim partially, and carry forward the remainder. This means you can claim solar tax credit spread over 5 years.

Combining federal tax credit with other solar incentives

The federal solar tax credit is the most substantial financial incentive for solar installation. There are many more incentives and rebates offered by states, local governments, and utility companies. Your eligibility for these depends on where you live.

Most of such incentives allow solar buyers to combine the benefits with federal tax credits, though some cannot be claimed together with ITC.

Here are some of the solar incentives available to solar buyers in the United States.

1. State tax credit

Similar to ITC, various states offer state tax credits that can be adjusted against the state taxes owed. This can be availed of together with the federal tax credit. However, there is a catch. When you claim a state tax credit, you will end up paying less tax on the state returns. This means more taxable income on federal tax returns. This indirectly translates to higher federal income tax. 

2. Rebates offered by states

Though these rebates differ from state to state, in general, there is no restriction on combining the rebates with the federal solar tax credit. You are allowed to avail of both at the same time.

3. Rebates offered by utility companies

With everyone having a zero-carbon goal, including utility companies, in their effort to increase the percentage of renewable energy generated, utility companies offer rebates to their consumers to install solar power systems and contribute to the grid through net metering. 

In most such rebates offered, the subsidy amount you receive from the utility company will be discounted from your tax returns. In other words, the cost of your solar installation you can use in your income tax returns for calculating tax credit must be the figure you get after reducing the rebate amount.

So, yes, this will affect your federal tax credit.

4. Gains from renewable energy certificates

Solar renewable energy certificates (SRECs) are given to solar system owners who have exported one MWh of electricity into the grid. The REC is a commodity that can be sold in the open market. These act as carbon credits and entities with carbon deficits buy them to offset their emissions.

When you sell your RECs, the amount received will be treated as your income in the computation of income tax. However, this will not have any effect on the federal tax credit.

What is the process to claim ITC?

You can claim the solar tax credit at the time you file your annual income tax returns. The computation of income tax remains the same. But once you arrive at the tax owed, you can subtract the tax credit from it.

If you are filing your own tax returns and would like some more help with this, you can refer to this article from EnergySage. 

If you are getting help from an accountant to file your returns, just remember to provide details of your solar installation to them on time. 

Eligibility checklist for the federal solar tax credit

Are you still unsure whether you are eligible for ITC? Here is a checklist for you.

1. The date of installation of the solar power system should fall between 1 January 2006 and 31 December 2023.
2. The premises where the solar system is installed need to be your primary or secondary place of residence in the United States.
3. You should own the solar panel system by purchasing it outright or financing it with a solar loan. The federal tax credit is not available for solar lease or PPA.
4. You should be a first-time buyer of the solar panel system. It has to be new or you are the first user. Or at least, no one should have claimed the federal tax credit for the same solar system earlier. For instance, if you buy second-hand solar panels and the first buyer has already claimed the tax credit, you are not eligible for the same. Or if you buy a solar home and the previous owner has claimed the tax credit, you cannot do so again.
5. If you are part of an off-site community solar project, the solar energy generated is credited to your account, provided it doesn’t exceed your electricity consumption. At the time of filing income tax returns, you can claim a tax credit under section-25D for your share in the community solar project.