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Solar Tax Credit: What If Your Tax Liability Is Too Small?

Guide to the solar tax credit and your federal tax liability
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The Solar Tax Credit, also known as the Solar Investment Tax Credit, allows you to save money when you install a solar power system via a reduction of your federal taxes. This tax credit has helped tens of thousands of households adopt solar power, because it can represent significant savings that are based on the initial installation cost of your solar. However, there are important things to know about what happens if your tax liability is too small for the investment tax credit, so if you’ve been wondering, “What happens if my solar tax credit is larger than my tax liability?” or, “What are my options if my solar tax credit is more than I owe in taxes?” then read on to learn more.

What Is The Solar Investment Tax Credit?

The Solar Investment Tax Credit (ITC) is a federal regulation that was enacted in 2006 to promote the adoption of solar energy in the United States via a tax credit that one can claim on their federal income taxes. This tax credit can be as high as 26% of the total cost of your solar energy system.

The ITC was first introduced in the Energy Policy Act of 2005, and was meant to be a two-year incentive. However, thanks to its positive uptake by consumers, and its impact on the economy, Congress has extended the ITC’s expiration date multiple times. According to the Solar Energy Industries Association (SEIA), “Since the ITC was enacted in 2006, the U.S. solar industry has grown by more than 10,000% - creating hundreds of thousands of jobs and investing billions of dollars in the U.S. economy in the process.”

Unless Congress renews the ITC extension it passed in December of 2020, this solar tax credit will only be available until 2024. Through 2022, the tax credit covers up to 26% of your total system cost, and after that, the maximum tax credit for solar power systems will be 22%, until the tax credit expires completely after December 31, 2023.

As a new solar power owner, you can only make a claim within the tax year when the system is installed and use begins, so it is essential to claim your tax credit during the next tax period to not miss out on valuable savings.

To encourage consumers to purchase systems that can support their power needs, there is no maximum amount or cap on how much you can claim for the solar tax credit. In addition, since solar power systems vary in capacity, prices are also different, which means that the potential savings from the ITC are also going to be different for each system. As such, it’s important to know everything about the ITC before purchasing a solar power system.

What Is Tax Liability?

Government spending, which aims to ensure citizens have access to public services, is funded by taxes. There are different forms of taxes, and each citizen and business must contribute their fair share.

The amount you owe in taxes is referred to as your tax liability. You might owe taxes to tax authorities like the IRS, or to the state and local governments, and thus, have a tax liability.

There are different factors that contribute to your tax liability, such as earnings from salaries and wages, or gains from the sale of assets. Examples of tax liabilities include capital gains tax, income tax, and sales tax.

Individuals who do not have any form of income, or who have a very low income, may not have any tax liability. Therefore, if they qualify for a tax credit, they do not have any tax liability to receive the credit against.

What Is A Tax Credit?

A tax credit is the ability to subtract a certain dollar amount from the tax amount that you owe. These tax credits help reduce your tax burden and reduce your tax liability.

In essence, tax liability represents your debt to the government, and in some cases, like with the solar tax credit, the government offers taxpayers ways to reduce the amount they owe. The government can offer tax credits to specific groups of people, locations, and industries in order to help them, or to advance a specific goal like the popularization of clean energy.

While they are somewhat similar, tax credits are different from tax deductions. A tax credit reduces the amount of tax owed, while a tax deduction reduces a taxpayer’s taxable income. Therefore, a $1 tax credit reduces the amount of taxes you owe by $1, while a $1 tax deduction will have a value that depends on your tax rate.

In short, you must owe at least as much money in taxes as the amount of your credit in order to receive the full amount of that solar tax credit.

Difference Between a Refundable and Non-Refundable Tax Credit

Tax credits come in two primary categories: refundable and non-refundable tax credits. With refundable tax credits, you will receive a refund of the balance if your tax credit exceeds your tax liability. For instance, assume that you are eligible for a $1,000 tax credit, but your tax liability is only $800. Along with having your tax liability completely covered, you are also entitled to a refund of $200.

As the name suggests, with non-refundable tax credits, you cannot receive any refund beyond the amount that the credit covers. As such, the maximum value you can receive is restricted to your total tax liability. This means you can lose out on the maximum potential benefits if your tax liability is too small for the investment tax credit. Suppose that you are eligible for a $1,000 tax credit, but your tax liability is only $600. While the tax credit will reduce your tax liability to $0, you will not get a refund for the additional $400 that was owed to you by the tax credit.

The Solar Investment Tax Credit is non-refundable, so you need to have enough solar tax liability available in order to receive the full value of that tax credit. However, there are options available if you don’t have enough solar tax liability in a single tax year.

How The Solar Investment Tax Credit Works

To make sure you understand the value of the tax credit and capitalize on its potential, it’s important to understand how the Solar Investment Tax Credit works.

The ITC was put in place to promote solar use, but not everyone who uses solar can qualify and be eligible to make a claim. To be eligible for the ITC, you must meet the following criteria:

  • Installation of the solar power system began between January 1, 2006, and December 31, 2023
  • Solar power system was installed in your primary or secondary residence within the United States
  • Solar power system is new or being put to use for the first time
  • You must own the solar power system, as leased equipment does not qualify (The company you lease the equipment from will receive the ITC, and will typically use it to help lower your lease payments)

Any costs incurred during the installation of the solar power system can be included in the tax credit. These include components such as mounting equipment, batteries, and wires, as well as related costs such as labor, assembly, and inspection.

After purchasing your solar power system, you should file for the Solar Investment Tax Credit within the tax year, just like you file your federal taxes. For the solar tax credit, you are required to use Form 5695 for Residential Energy Credits. Regardless of whether you use the federal income tax or the alternative income tax to calculate your tax liability, you can still claim the full value of the ITC and receive residential energy credit, as it can be used against both.

The ITC is not the same as an up-front ‘discount’ on your solar, since it is not applied to the cost of your solar power system at the time of purchase. Instead, you pay for the system (or finance it with a solar loan) and then it is your responsibility to claim the tax credit when you file your taxes.

One thing to note about the IRS solar tax credit is that it is a non-refundable tax credit. However, this does not mean you will miss out on its full benefits if you have a small tax liability. To further incentivize solar power system installation, there is a tax credit carryover rule if your tax liability is too small for the investment tax credit. Your tax credit can be deducted from federal income taxes over several years, but this tax credit carryover can only happen during the period the IRS solar tax credit is in effect, so you need to have used the full credit by the time the credit expires on January 1, 2024.

What Forms Are Needed To Claim The ITC?

Good news: Claiming the ITC is easy! Once you've confirmed that you are eligible, you will be required to fill out and attach IRS Form 5695 while filing your federal taxes. The ITC forms ensure you get the full value of your tax credit.

Along with solar power, Tax Form 5695 helps taxpayers calculate tax credits for various other residential energy improvements such as solar energy storage, solar water heating, geothermal heat pumps, wind turbines, and fuel cells.

Completing Form 5695 may also involve working out rollover taxes if the value of your tax credit exceeds your tax liability. Once you are done, take the value that will be credited and enter it in the appropriate field of your Schedule 3 (Form 1040) - Additional Credits and Payments, and then enter your total credits on your Form 1040.

Each individual's tax situation is unique, so if you have questions about your eligibility for the ITC, or how the solar tax credit factors into your overall tax return, it's best to seek the counsel of a professional tax consultant.

When Can I Claim The Solar Investment Tax Credit?

One of the requirements of claiming the Solar Investment Tax Credit is that you do so within the same tax year that your installation is completed. This period begins after your solar power system has been fully installed and is operational. If the value of the tax credit you are owed exceeds your solar tax liability during that tax year, you can still capitalize on its full value thanks to a unique provision of the credit.

Though it is a non-refundable tax credit, the ITC employs a solar tax credit rollover system that allows you to collect your credit balance in subsequent years. Based on the present guidelines, you can rollover the balance for the duration of the solar tax credit until it expires at the end of 2023.

Can I Claim The ITC If I Purchase My Solar Power System With A Solar Loan?

Yes, even if you purchase your solar power system with a solar loan, you can still claim the full value of the Solar Tax Credit, and if you have enough tax liability, you can receive the full tax credit in the first year. With a solar loan, it’s possible to pay as little as $0 down when your solar power system is installed, while still receiving the valuable tax credit that’s based on the full value of your solar power system.

Is It Possible To Claim The ITC After A New Home Purchase?

Due to the benefits of solar power systems, they have now become a key consideration for many homebuyers. If you are considering the purchase of a new house with a solar power system, you are likely still eligible for the Solar Investment Tax Credit. (If you’re in this situation, check out the article we wrote to answer the question, “Is Solar a Good Investment for First-Time Homebuyers?”)

Even if the installation occurred over one year prior to the purchase or move-in date, the ITC is still applicable. This is because the duration upon which it should be claimed only begins once the system is in use. Therefore, as long as you are the owner and first-time user, you can claim the ITC regardless of the date the house was built or sold. For instance, if you buy a house (primary or secondary) in 2022 but don’t move in until 2023, you can still make your ITC claim during the 2023 tax year.

Can I Carry Forward The Solar ITC If My Tax Bill Is Smaller Than My Tax Credit?

To put it simply, yes, you can carry forward the Solar Tax Credit if your tax bill is smaller than your tax credit! A carry forward is a provision in the tax law that allows taxpayers to apply some of their unused credits, deductions, or losses to a future tax year.

You may find that your tax liability is too small for the investment tax credit in a single year due to a low tax liability, or because you are eligible for a high solar ITC. For instance, with a 26% tax credit, if the cost of installing your solar power system is $10,000, you may qualify for a solar tax credit of up to $2,600. However, if your total tax liability for that tax year is $1,500, then the maximum amount that can be received in that year is $1,500, and you will need to use a tax credit carryforward to receive the remaining $1,100.

In the government’s quest to ensure consumers enjoy the full value of the ITC, there is a provision that allows you to claim the balance in the following years. However, if there is a significant difference between your tax credit and tax liability, there's a chance you may miss out on some benefits of the tax credit. Current guidelines stipulate that solar tax credits can only be claimed for as long as the ITC is active, which ends on December 31, 2023.

What Options Are Available If I Have No Tax Liability?

People on fixed incomes, or those with little to no tax liabilities like retirees, may be wondering, "How does the solar tax credit work if I don't owe taxes?"

Since tax credits work by reducing your federals taxes, certain groups of individuals may miss out on those benefits. While you may not capitalize on the tax credit if you have no tax liability, investing in solar power is still a worthwhile choice that can provide overall savings on your energy costs.

Some of the benefits of going solar include:

  • Reduce or even eliminate your utility costs
  • Earn net metering credits in some areas to offset additional utility costs
  • Control where your electricity comes from, and how it’s used
  • Contribute to a greener and more sustainable world

Another option for those with no tax liability is a solar lease or power purchase agreement (PPA). With these types of solar financing agreements, the company that owns the solar power system receives the ITC using their own tax liability, and then they can pass along some or all of those savings to the homeowner.

How Much Can I Save With The Solar Investment Tax Credit?

Undoubtedly, the Solar Investment Tax Credit is a great incentive for investing in solar power. In addition to reducing your utility bills, you can also earn additional savings of up to 26% on your federal taxes.

At Palmetto, we are committed to leading the world towards a clean energy future. Are you interested in capitalizing on the benefits of solar power and the solar tax credit? We are here to provide you with the necessary information and support you need to become a solar-powered home. Begin your journey by using our Free Cost-Savings Calculator to find out how much you can save by installing a solar power system, which includes the amount you’d save thanks to the Solar Investment Tax Credit.

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