Energy Tax Credit

What Is an Energy Tax Credit?

An energy tax credit is a government-sponsored incentive that reduces the cost for people and businesses to use alternative energy resources. Eligible individuals or entities who meet the criteria are reimbursed for their efforts to make the planet “greener” when paying income taxes, with the credit amount being wiped, dollar for dollar, from the total sum owed to the Internal Revenue Service (IRS).

There are currently various federal energy-related tax incentives in motion. Each one carries unique requirements and serves different portions of the population, with some targeted at individual homeowners and others at companies.

Key Takeaways

  • An energy tax credit is a government incentive that reduces the cost for people and businesses to use alternative energy resources.
  • Those who meet the criteria are reimbursed when paying income taxes, with the credit amount either reducing the total sum owed to the IRS or being added to your refund if you are due one.
  • The Inflation Reduction Act, a landmark piece of legislation signed into law in August 2022, engineered a major revamp of energy tax credits.
  • There are two major energy tax credits available to homeowners: the Energy Efficient Home Improvement Credit and the Residential Clean Energy Credit.
  • The U.S. government also offers various energy-related tax credits to businesses that spend money on reducing energy consumption and pollution.

Tax Deductions Vs. Tax Credits

Understanding Energy Tax Credits

Coming up with ways to improve the quality of the air we breathe is a key priority for most of today’s politicians. Increasing pollution that is contributing to the heating up of the planet has become one of the biggest topics of the 21st century, prompting governments across the world to spend record amounts of money to make the transition to greener technologies more affordable for the population.

A popular method has been to introduce various energy-related tax credits. Rather than give people an immediate discount when purchasing a qualifying product, these credits work by reducing the amount of tax owed. For example, if Lisa’s purchase of solar panels for $30,000 qualifies her for a 30% tax credit, she can deduct $9,000 from the money she owes the IRS when the time comes for her to pay taxes.

The Inflation Reduction Act, a landmark piece of legislation signed into law on Aug. 16, 2022 by President Joe Biden, ordered a major revamp of energy tax credits. Many of the previous credits in existence have been renamed, improved, and extended, and some new incentives have been added to help people and businesses afford the costs of “going green.”

The Inflation Reduction Act introduced much more generous energy tax credits.

Residential Energy Tax Credits

As of August 2022, there are two major energy tax credits available to homeowners:

Energy Efficient Home Improvement Credit

This particular credit, previously known as the “Nonbusiness Energy Property Credit,” is available to homeowners who install insulation, windows, doors, and other energy-saving improvements. Under current rules it’s possible to get 10% off the costs covered by the credit. However, the maximum you can get is $500, and that’s a lifetime limit, not an annual one.

That’s all set to change on Jan. 1, 2023, when the Energy Efficient Home Improvement Credit kicks in, offering homeowners a 30% tax credit to cover some of the cost of eligible home improvements. The maximum limit also increases, to $1,200 (or $2,000 for certain heat pumps, biomass stoves, and boilers), and it now resets every year until 2032, meaning it’s possible to save five figures in total.

Annual limits for individual types of qualifying alterations were also improved as of 2023. They are:

  • Home energy audits – $150
  • Exterior door – $250, with a $500 total for all exterior doors
  • Exterior windows and skylights; central air conditioners; electric panels and certain related equipment; natural gas, propane, or oil water heaters; natural gas, propane, or oil furnaces or hot water boilers – $600
  • Electric or natural gas heat pump water heaters, electric or natural gas heat pumps, and biomass stoves and boilers – $2,000

After 2024 items will need to have a specially generated product identification number to qualify for the Energy Efficient Home Improvement Credit.

Residential Clean Energy Credit

Another credit that the Inflation Reduction Act extended and revamped is the Residential Energy Efficient Property Credit. This particular tax break, now called the “Residential Clean Energy Credit,” continues to offer help toward the installation cost of solar, wind, geothermal, and biomass renewable energy—but on more generous terms than before.

Under the old law the credit was worth 26% of the outlay and scheduled to drop to 23% in 2023 before expiring in 2024. Now, with the Inflation Reduction Act, it will jump up to 30% and stay there until 2032 before dropping to 26% in 2033 and then 22% in its final year.

The scope of the credit has also adjusted slightly. From 2023 the new incentive will no longer apply to biomass furnaces and water heaters, but it will cover battery-storage technology with a capacity of at least three kilowatt-hours (3kWh).

Homeowners should retain any documentation related to purchases that qualify for energy tax credits in case they are audited by the IRS.

Business Energy Tax Credits

The U.S. government also offers various energy-related tax credits to businesses. In many cases companies that spend money on reducing energy consumption and pollution are able to claw back some of their outlay.

Examples include the production tax credit (PTC) and investment tax credit (ITC), which allow taxpayers to deduct a percentage of the cost of installing a renewable energy system, and the 179D Energy Efficient Buildings Tax Deduction, which enables building owners to claim a tax deduction for installing energy-efficient qualifying systems that lower energy consumption.

Manufacturers of components that reduce carbon emissions, such as solar and wind energy, inverters, and batteries, are also rewarded with tax discounts.

Other Ways To Save

In addition to federal tax breaks, taxpayers may want to check available rebates for energy-efficient purchases. The Inflation Reduction Act established two rebate programs that are predominantly designed to help low- and middle-income families. Moreover, many appliances, building products, electronics, heating and cooling equipment, and water heaters come with rebates through local utility companies.

Some rebates are available immediately after purchase or following installation. Typically, the total rebate amount depends on the product. North Carolina State University’s database of state incentives for renewables & efficiency (DSIRE), recommended by the U.S. Department of Energy, offers a collection of both federal and state incentives.

How Do Tax Credits Work?

Tax credits reduce the amount of income tax you owe. You get the full amount of money you were promised when you pay your taxes. For example, if you have a tax credit of $1,000, you would owe $1,000 less in income tax to the IRS (or you would have $1,000 added to your refund if you are due one).

Can I Claim New Windows on My Taxes?

Yes, provided they meet the requirements. In 2023 you may be entitled to a tax credit covering 30% of the cost of installing energy-efficient windows, up to a maximum of $600 per year.

What Documentation Do I Need to Submit to Receive Energy Tax Credits?

You don’t generally need to supply any documentation with your tax returns. All that’s usually required is that you answer the questions you’re asked on the forms truthfully. That doesn’t mean you should throw everything out, though. It’s advisable to keep hold of documentation related to the purchase of something for which you requested a tax break. The IRS may one day want proof of what you declared, and it’s much easier to prove that with all the original documentation still in your possession.

The Bottom Line

The U.S. government, as evident in the Inflation Reduction Act, is eager to get people to go green. Never before has so much money been available to help individuals and businesses make the jump, and it would be foolish not to take advantage in some way if you have the financial means to do so.

If up-front costs are what have held people and businesses back from investing in green technologies, energy credits should help make these changes happen—and sooner than they might otherwise. With the government’s help, the savings can be considerable.

Article Sources
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  2. Internal Revenue Service. "Instructions for Form 5695, Residential Energy Credits." Page 1.

  3. “H.R.5376 - Inflation Reduction Act of 2022.”

  4. United States Environmental Protection Agency. "Renewable Electricity Production Tax Credit Information."

  5. Energy Star. “Federal Income Tax Credits and Other Incentives for Energy Efficiency.”

  6. U.S. Department of Energy. "Tax Credits, Rebates & Savings."

  7. North Carolina State University: NC Clean Energy Technology Center. "Database of State Incentives for Renewables & Efficiency (DSIRE)."

  8. eFile. "Tax Credits for 2021 Returns."