What Exactly is a Tax Credit?

A tax credit is a monetary sum that taxpayers can utilize to diminish their owed amount of money. It’s distinct from tax deductions, which reduce taxable income rather than the tax obligation itself. Moreover, deductions lower the final tax liability within an individual’s tax bracket, while tax credits directly decrease the owed taxes on a dollar-for-dollar basis.

Both federal and state governments provide tax credits to qualifying individuals or entities as incentives to adopt practices that contribute positively to the environment, economy, and other significant areas.

Federal Tax Incentives for Solar Energy

The federal residential solar energy credit, also known as the Investment Tax Credit (ITC), was introduced by the U.S. government in 2006. Since its inception, the solar energy industry has experienced significant growth, contributing to 50% of all new electricity-generating capacity added in the U.S. at the beginning of 2022.

Individuals who invest in and install a solar photovoltaic (PV) system are eligible to claim the federal residential solar energy credit. This tax credit offsets a portion of the eligible costs associated with installing solar power systems and reduces the taxpayer’s overall tax liability. It’s important to note that this credit is nonrefundable, meaning it can only reduce tax liability until it reaches $0, and any remaining credit cannot be refunded.

To qualify for the tax credit, the solar PV system must be installed and operational within the same tax year and must generate electricity for a residence in the United States. The Internal Revenue Service (IRS) defines systems that are “placed in service” as those with completed installations.

As per the Consolidated Appropriations Act of 2021, tax credits for solar energy systems have been extended with a gradual reduction in credit value. The current tax credit values are as follows:

• 30% for systems placed in service by December 31, 2019.
• 26% for systems placed in service after December 31, 2019, and before January 1, 2023.
• 22% for systems placed in service after December 31, 2022, and before January 1, 2024.
• The tax credit expires after December 31, 2023, with no plans for renewal. While the credit covers only a portion of the costs, there is no maximum limit for claims.

Average Savings from Solar Energy in the U.S.

In addition to reducing carbon footprints, solar power can lead to significant savings on electricity bills. Although solar systems can incur costs of up to $17,000, the combination of federal solar tax credits and reduced power bills can result in net savings.

On average, Americans save approximately $1,500 per year by switching to solar energy, translating to $37,500 over 25 years. Furthermore, a 26% tax credit can save $4,420 on a $17,000 solar-powered system, reducing the installation cost to $12,180. Based on these figures, solar energy begins to pay for itself after approximately eight years.

Overall savings can range from $10,000 to $90,000, depending on factors such as local grid prices, roof size, location, state incentives, and energy consumption.

Eligibility for Federal Solar Tax Credit

Individuals may qualify for the tax credit if they meet the following criteria:

• The solar PV system was installed between January 1, 2006, and December 31, 2023.
• The system is installed at the taxpayer’s primary or secondary residence in the U.S. or in an off-site community solar project.
• The taxpayer owns the solar PV system and is using it for the first time.
• It’s important to consider that other federal or state incentives may impact the tax credits available.

Expenses Covered by Federal Solar Tax Credit

The federal solar tax credit covers the following expenses:

• Solar PV panels or PV cells that power an attic fan.
• Contractor labor costs for onsite preparation, assembly, or original installation, including permit fees, inspection costs, and developer fees.
• Balance-of-system equipment, including wiring, inverters, and mounting equipment.
• Energy storage devices charged exclusively by associated solar PV panels.
• Sales taxes on eligible expenses.
• How to Claim the Federal Solar Tax Credit

To claim the federal solar tax credit:

• Download IRS Form 5695 and include it with your tax return.
• Calculate your overall project costs and enter them on line 1.
• Complete the calculations on lines 6a and 6b.
• If solar power is your sole claimed energy source and you don’t have any carry-forward amounts from the previous year, skip lines 7 through 12.
• Add lines 6b, 11, and 12, and enter the result on line 13.
• Calculate tax liability limitations on line 14.
• Complete lines 15 and 16.

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