Understanding the Federal Tax Credit for Solar Panels
Updated: Dec 22, 2022
*The information in this article is intended to be true, however the author is not a certified tax professional or CPA. It is recommended that you seek out independent tax advice from a certified accountant for professional analysis of how exactly the Solar Investment Tax Credit would work for you.
The Solar Investment Tax Credit - or Solar ITC - is a federal subsidy that aims to help homeowners with the affordability of owning your energy, such as equipping your home with solar panels. This incentive is delivered in the form of a non-refundable tax credit by filing IRS Form 5695 with your annual tax filing.
A non-refundable tax credit is a dollar-for-dollar reduction to your income tax liability. In other words, for every tax credit dollar you receive, you are able to eliminate an equal dollar from the money you owe Uncle Sam for that tax year. However, as a non-refundable tax credit, you can only claim a maximum of what you owed for that year. Any leftover credit above what you were able to redeem can be rolled forward year-after-year until there is no more left to claim.
Let's look at an example to see how it works given a few different situations:
Homeowner John decides he wants to go solar so that he own and produce his energy at home, instead of continuing to pay utility prices for electricity.
The total cost of John's solar equipment comes out to $20,000. At the current ITC rate of 26%, John is eligible for a tax credit of $5,200 (20000 * 26%). For example purposes, let's assume that John's total tax liability for the year is $6,000. This works out differently based on John's tax scenario:
John is a W-2 employee, or makes tax payments regularly throughout the year. He is used to getting a small tax refund when he files.
Through his regular tax contributions, John has given the IRS a total of $6500 prior to filing his taxes. Without applying the tax credit, John would have received a refund of $500 (6500 paid - 6000 owed). With the solar ITC, John could now expect a refund of $5,700 (6500 paid - 800 owed).
Rather than owing Uncle Sam $6000 for that tax year, John only owed them $800 (6000 owed - 5200 credit), meaning that he was able to recoup a much larger portion of the tax contributions that he had already made.
John is self-employed and pays his taxes once per year. He is used to writing a check to the IRS when he files.
When John files his taxes, he has not yet made any contributions towards his tax debt for the last year. Therefore, in a regular year without the solar ITC, he would owe the IRS his full tax liability - in this case $6000.
With the federal tax credit applied, John would only owe the IRS $800, saving himself $5200 (6000 owed - 5200 credit).
John is retired. He's been able to build up strong retirement accounts, but is required to pay taxes when he withdraws his money.
John is living off of a fixed income and doesn't normally have much tax liability, so traditional financing for solar equipment makes less sense for him. He has plenty of cash available thanks to years of hard work and investmenting towards his retirement, but wants to avoid paying high taxes. With the tax credit, he can.
Assuming a tax rate of 25%, John would normally have to pay $5000 to the IRS if he withdrew $20,000 from his retirement account. With the solar ITC, he could pull out the $20,000 from his retirement account, not owe the IRS anything, and still have $200 worth of credit to rollover (5200 credit - 5000 owed), assuming there is no additional tax liability.
As we've seen, the Solar Investment Tax Credit works differently for different situations.
When considering the benefits of going solar for your own home, it's important to understand the tax credit and verify exactly how it would work for your tax situation, as it could make a huge difference in your financial benefit of flipping the switch to solar.
To learn more about owning your energy with solar, get in touch with us here.