August 22nd, 2022
Solar panels are becoming increasingly popular as both individuals and businesses are looking to maximize energy efficient activities while enjoying tax breaks. This means that your clients are more likely to inquire about the tax treatment for solar panels and other systems, making it critical to differentiate between the Federal tax credits for homeowners and commercial entities.
The Federal Investment Tax Credit (ITC) for homeowners and the Inflation Reduction Act recently signed by President Biden are tax credits for eligible solar photovoltaic (PV) systems. This credit can be applied for other energy efficient improvements as well.
Eligible solar PVs must be placed in service during the tax year and generate electricity for a dwelling located in the United States. Your clients must also meet the following requirements:
Eligible expenses include:
For tax years 2020 and 2021, homeowners can claim a credit of 26% of qualifying costs. The Inflation Reduction Act expands the credit for tax years 2022 through 2032 to a credit of 30% of qualifying costs. This tax credit is unique in the fact that there is no maximum credit amounts or threshold limitations. Form 5695, Part I, must be completed with the Federal Form 1040 in order to claim the credit.
In some cases, state governments offer rebates and tax credits that follow the Federal credit. When state credits are claimed, it reduces the amount of the state income tax deduction on Schedule A. This may result in a higher tax liability, making the two credits not additive. Be sure you check into rebates, certificates, and credits in the state your client files in to maximize tax savings.
There is no depreciation deduction available unless your clients have a qualifying business where the solar panels are installed.
This credit is nonrefundable, meaning your clients won’t get a refund for credit amounts that exceed their tax liability. However, the credit will carry forward into the next tax year.
Businesses are also able to take the Federal Investment Tax Credit and the 30% credit in the Inflation Reduction Act. However, they must follow different regulations. This applies to all Schedule C, Schedule E, and business tax return clients.
To take the ITC or credit in the Inflation Reduction Act, businesses must meet a few different requirements:
The eligible expenses for businesses are similar to those of individual tax clients, including:
The business must have begun or hired a company to begin the construction of a solar PV system before year-end to take the credit. Businesses will need to file Form 3468 on the tax return to claim the credit. Just like individuals, businesses are also able to take the 30% credit from the Inflation Reduction Act to boost tax savings.
Like individuals, businesses can receive state rebates and credits as well. These are usually one-time rebates that occur when the solar PV system is purchased. Businesses may be entitled to receive revenue from the sale of energy credits, payments for state performance-based incentives, property tax exemptions, nonprofit grants, and energy financing.
Since solar PV systems are considered assets of the business, depreciation deductions can be taken. Businesses may take a combination of bonus depreciation and Modified Accelerated Cost Recovery System (MACRS) to write off the solar PV system. The depreciable base is the total cost of the solar PV system less one-half of the credit amount.
For example, your client placed a $500,000 solar PV system in service in 2022. Since the ITC credit rate is 30%, 15% of $500,000 cost is $75,000, making the basis for depreciation $425,000.
Between 2019 and 2022, businesses can take 100% of bonus depreciation on qualifying solar systems, while the deduction drops 20% each year after 2022. This means if your client placed a solar PV system in service during 2022, they would be able to take the entire $425,000 in bonus depreciation. However, if they place a system in service during 2023, they would only be able to immediately expense 80% of the depreciable base, with the remaining 20% depreciated under MACRS.
Unused ITC can be carried back one year and forward for 20. After the 20-year mark, half of the remaining credit can be deducted while the other half expires.
Understanding the difference between the Federal Investment Tax Credit for individuals and businesses is critical to filing accurate returns for your clients. This credit is a great opportunity for your clients to take steps towards renewable energy while enjoying the tax benefits.
U.S. Department of Energy. “Homeowner’s Guide to the Federal Tax Credit for Solar Photovoltaics.” U.S. Department of Energy, Jan 2021, Accessed 15 August 2022.
U.S. Department of Energy. “Guide to the Federal Investment Tax Credit for Commercial Solar Photovoltaics.” U.S. Department of Energy, Jan 2020, Accessed 15 August 2022.
H.R.5376 Inflation Reduction Act of 2022. https://www.congress.gov/bill/117th-congress/house-bill/5376. Accessed 22 August 2022.
By Rich Walden, CPA
University of Illinois Tax School Instructor
Disclaimer: The information referenced in Tax School’s blog is accurate at the date of publication. You may contact firstname.lastname@example.org if you have more up-to-date, supported information and we will create an addendum.
University of Illinois Tax School is not responsible for any errors or omissions, or for the results obtained from the use of this information. All information in this site is provided “as is”, with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information. This blog and the information contained herein does not constitute tax client advice.