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Tuesday, January 1, 2019

Tax Credit & The $35k Tesla Model 3

The New Year is here and with it, the tax credit for new Tesla vehicles drops by 50%, from $7500 to $3750. In July of 2018, Tesla sold their 200,000th EV in the US; that meant that the tax credit for Tesla's vehicles was set to begin its phase-out by dropping to $3750 on January 1st, 2019; then to $1875 on July 1st, 2019; and finally vanishing as we ring in 2020.

You will undoubtedly see headlines such as "All Tesla Cars Just Become $3,750 More Expensive", but that may not be completely true.

There are a couple bills that could extend the tax credit. One extends it for 3 years, while the other extends it for 10 years. There is even a 3rd bill related to the EV tax credit, but this third one seeks to eliminate the credit immediately. For this exercise, we'll assume that none of these bills pass, although we have our fingers crossed for the first two.

The EV Tax Credit & You

The incentive dropping might not be as bad as it seems at first. The way that the tax credit works, it can only offset your tax liability. The US tax credit is a non-refundable credit with no carry-forward provision. This means to take full advantage of the $7500 credit, you would have needed to have a tax liability of $7500 or more.

To clarify, your tax liability is not the tax bill you may have to pay when you file. Rather, this is the sum of all your federal withholdings throughout the year then adjusted by the payment or refund from tax time. I'll give a few simplified examples, but taxes are complicated, so consult your own tax professional as needed.

Half Tax Credit Amount Might Be Just Right

If you've been holding out for the more affordable $35k version of the Model 3, you might be disappointed if the tax credit is halved before you can pick up your car. The good news is that it might not matter. Remember the two points from above: One, you can only use the tax credit to offset your own tax liability (it is not just a payment to you); and two, there is no carry-forward to the next tax year.

There are plenty of people with large tax bills that prefer to buy affordable cars, but there are also plenty of people on the reservation list that are stretching their budget to buy their first Tesla. If you are doing "the Tesla Stretch" then this reduction in the tax incentive might not matter to you.

How Much Tax Credit Can You Use?

You can find your gross tax liability on line 47 of Form 1040, on line 30 of Form 1040A, or on line 10 of Form 1040EZ. If your income is similar this year to last year's, then last year's taxes will give you a good idea. However, if you don't want to dig out your old taxes, let's run some back of the napkin numbers.

Let's see what income you would have needed to take full advantage of the $7500 tax credit. Before we start with the numbers, it is impossible to have a single answer to a tax question because everyone's situation is different and will be impacted by things like:
  • Filing/marriage status 
  • Mortgage interest
  • 401(k) contributions
  • State and Local Taxes You Paid
  • Interest You Paid
  • Gifts to Charity
  • Medical Expenses
  • Casualty and Theft Losses
  • Personal Legal Bills
  • Health Insurance Premiums
  • Babysitter Payments While Volunteering
  • Lifetime Learning Expenses 
  • Self-employed Social Security
For this exercise, I'll assume Married Filing Jointly, using just the standard deduction, making some pre-tax 401(k) deposits (assuming you're using a traditional 401(k) and not a Roth 401(k)). If you're over 50 years old, you can put an additional $6,000 into your 401(k), but for this example, I'll assume you are under 50 or not opting for the $6k catch up. If this is not your situation, the exercise will show you how to construct your own.

For a household to have a $7500 in tax liability, you first need to have more income than the standard $24,400 deduction then there's the maxed out pre-tax 401(k), that's $19,000 for 2019. Then you enter the 10% bracket for the next $19,400. Next, you enter the 12% bracket. You'll need to earn another $46,330 in this bracket to hit the full $7500 in tax liability.

Adding this all up, to utilize the entire $7500 tax incentive, you'd need to have a household income of ~$109,000+. According to Bankrate, only 20% of US households have a $100,000+ income.

How Much Tax Credit Can You Use?

Using the same back of the napkin math for the half tax credit, you'd need to have a ~$78,000 household income to qualify for the full $3,750 tax credit. According to the U.S. Census Bureau, the median household income is ~$60,000.  So for most US households, a $3750 tax credit is adequate to refund all of your tax liabilities. The average Tesla buyer is likely to be above the median income, but even if you are ~$20k above the median, the half tax credit is enough to wipe away most of your federal tax liability for 2019.

Conclusion: Tax Credit for the $35,000 Model 3

If you've been holding out for the $35k base model variant of the Model 3, but you're bummed that the tax credit is currently cut in half, the odds are that the half tax credit is nearly as useful. We just need to see the $35k Model 3 shipped in the first half of 2019.

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