As you may know, residents (and businesses) can take a 30-percent federal tax credit when purchasing solar PV systems. You also may know, however, that reading about tax rules is about as much fun as watching silicon degrade, molecule by molecule. Luckily, the freshly amended investment tax credit (ITC) is fairly straight forward. It provides a tax credit worth up to 30 percent of total system costs, with no dollar amount cap. But what, exactly, is a tax credit? And how is it different from a tax deduction?
[DISCLAIMER: I am not a tax professional. In fact, I know very little about federal tax laws. The closest I come to the stuff is via TurboTax, each spring. In sum, you'd be a fool to assume that this post should be taken as tax advice. It should not be taken as such, and its accuracy is not guaranteed. Contact a tax attorney if you want legal advice on your tax situation.]
Anyway, the short answer is that a tax credit reduces your federal tax liability directly. Subtracted from your tax liability (taxes owed), it’s taken after all other reductions are made. A tax deduction, by contrast, provides tax relief in a more oblique manner. Tax deductions are subtracted from gross income, yielding taxable income — the basis from which your tax liability is calculated. An example sheds some light:
For simplicity, assume that this year you have an income of $100,000 and are in the 30 percent tax bracket. Come April 15th, 2010, you’d owe the feds $30,000 (ignoring deductions and other factors that affect your taxable income).
Now, imagine that in 2009 you install a solar PV array costing a total of $30,000. Under current ITC rules, you’d be permitted to take a 30-percent tax credit worth $9,000 (30% x $30,000 = $9,000). Since it’s a credit, you’re permitted to subtract this amount directly from your tax liability: $30,000 – $9,000 = $21,000 in taxes owed, thanks to the ITC.
What would things look like if the feds offered a 30-percent tax deduction instead of a credit? The outcome is not as promising. As noted above, tax deductions are taken before arriving at taxable income, which is then used to determine your tax liability. In our example, that would look like this:
$100,000 – $9,000 (30-percent tax deduction) = $91,000 (this is your new taxable income, ignoring all other deductions)
$91,000 x 30% = $27,300 in taxes owed
Clearly, the tax credit provides stronger incentive for residents (and firms) to invest in solar PV systems. In our example, the credit would save you $6,300 when compared to the hypothetical tax deduction. Further clarity is provided by this simple post from the Financial Web,
Tax credits can be more valuable than deductions, although somewhat more difficult to qualify for. Let’s assume, for example, that you owe $1,000 in tax. For the purposes of this illustration, you are eligible for either a $1,000 tax deduction or a $1,000 tax credit. Which would you choose? Well, the deduction, when subtracted from your gross income to get your taxable income, will only decrease the tax you owe by about $10. The tax credit would be subtracted directly from the tax you owe, which would mean that you owe no tax at all.
I hope this post provides some clarity on these topics. If you’ve got any questions or suggestions, please don’t hesitate to contribute.
Finally, the Solar Energies Industry Association (SEIA) provides a number of useful resources on the ITC and other federal initiatives.
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