Also see: 2023 Year-End Tax Planning for Businesses.

2023 Year-End Tax Planning for Individuals (Client Letter Included)

(Parker Tax Publishing November 2023)

The first installment of Parker's annual two-part series on year-end tax planning recaps 2023's major changes affecting individual taxpayers and provides strategies clients can use to minimize their 2023 tax bill.

Practice Aid: Use Parker's Sample Client Letter as a template or just sign your name at the bottom. See Our Sample Client Letter (Individuals).

Introduction

The Inflation Reduction Act of 2022 expanded the clean energy credits available to individual taxpayers, and many of its provisions took effect January 1, 2023. In addition, taxpayers can take advantage of increased retirement plan contributions this year as a result of the SECURE 2.0 Act.

The following are some year-end considerations to review with clients, as well as some actions that may help reduce a client's 2023 tax bill.

Individual Tax Brackets Increased for 2023

For 2023, the top tax rate of 37 percent applies to incomes over $578,100 (single and head of household), $693,750 (married filing jointly and surviving spouse), and $346,875 (married filing separately). For 2024, inflation has pushed those brackets to $609,350 (single and head of household), $731,200 (married individuals filing jointly and surviving spouses), and $365,600 (married filing separately). However, high-income taxpayers are also subject to the 3.8 percent net investment income tax on the lesser of net investment income or the excess of modified adjusted gross income over the following threshold amounts: $250,000 for married filing jointly or qualifying widow(er), $125,000 for married filing separately, and $200,000 in all other cases. These amounts are not adjusted for inflation. High-income taxpayers are also subject to the .9 percent additional Medicare tax on certain income that is more than a threshold amount. The types of income subject to this tax include Medicare wages, self-employment income, and railroad retirement compensation. For taxpayers subject to one or both of these additional taxes, there are certain actions (discussed below) that can be taken to mitigate the damage of these additional taxes. It's worth noting that these taxes are not deductible.

For married couples, employers do not take a spouse's self-employment income or wages into account when calculating the .9 percent additional Medicare tax withholding for an employee. If a married couple's income will exceed the $250,000 threshold in 2023, and they have not made enough tax payments to cover the additional .9 percent tax, a Form W-4 should be filed with the taxpayer's employer before year end to have an additional amount deducted from the client's wages. Otherwise, the couple may get hit with underpayment of tax penalties.

The due date for filing 2023 tax returns is Monday, April 15, 2024.

Standard Deduction versus Itemized Deductions

It's important to determine whether it makes sense for a client to itemize deductions as there are steps that can be taken which will give a taxpayer enough deductions to itemize. For 2023, the standard deduction amounts are: $13,850 (single); $20,800 (head of household); $27,700 (married filing jointly and surviving spouse); and $13,850 (married filing separately). The additional standard deduction amount for taxpayers who are 65 or older or blind is $1,500. This additional amount is increased to $1,850 if the individual is also unmarried and not a surviving spouse.

If a client's itemized deductions in 2023 will be close to his or her standard deduction amount, consideration should be given to paying certain deductible amounts (such as medical and charitable expenses) in 2023 rather than 2024 to the extent possible, or vice versa. In essence, determine whether bunching deductions in one year and taking the standard deduction in alternate years can provide a net-tax benefit over the two-year period.

Filing Status

Generally, a return filed as married filing separately is not beneficial for tax purposes. However, in some unique cases, such as when one spouse earns substantially less or when one spouse may be subject to IRS penalties for issues relating to tax reporting, it may be advantageous to use the married filing separately tax status. Additionally, if one spouse was not a full-year U.S. resident, an election is available to file a joint tax return where such joint filing status would otherwise not be available. Depending on each individual's taxable income, this could help the couple reduce their joint tax liability.

Income, Deductions, and Exclusions from Income Relating to a Taxpayer's Residence

Home Office Expenses: More individuals are working from home these days, and that means that more clients will be asking whether they qualify for the home office deduction. For employees, expenses relating to working from home are not deductible. The Tax Cuts and Jobs Act of 2017 (TCJA) eliminated the deductibility of such expenses when it suspended the deduction for miscellaneous itemized expenses that was previously available. However, for self-employed individuals, home office tax deductions are still available. In addition, because individuals are limited to a maximum $10,000 deduction for state income and property taxes, allocating a portion of the homeowner's tax expenses to the portion of a taxpayer's home used for business, can increase deductions for these amounts that would otherwise be lost.

Mortgage Interest Deduction: For clients who sold their principal residence during the year and acquired a new principal residence, the mortgage interest deduction may be limited. For mortgages of more than $750,000 obtained after December 14, 2017, the deduction is limited to the portion of the interest allocable to $750,000 ($375,000 in the case of married taxpayers filing separately). For a mortgage on a principal residence acquired before December 16, 2017, the limitation applies to mortgages of $1,000,000 ($500,000 in the case of married taxpayers filing separately) or less. However, for clients operating a business from home, an allocable portion of the mortgage interest is not subject to these limitations.

Deductions for Interest on Home Equity Debt: Interest on home equity debt may be deductible where a client used that debt to buy, build, or substantially improve his or her home. For example, interest on a home equity loan used to build an addition is typically deductible, while interest on the same loan used to pay personal expenses, such as credit card debt, is not. Thus, it's important to document the portion of the debt for which an interest deduction is taken.

Gain or Loss on the Sale of a Home: If a client sold his or her home this year, up to $250,000 ($500,000 for married filing jointly) of the gain on the sale is excludible from income. However, this amount is reduced if part of the home was rented out or used for business purposes. Generally, a loss on the sale of a home is not deductible. But again, if a portion of the home was rented or was otherwise used for business, the loss attributable to that portion of the home is deductible.

Exclusion from Gross Income of Discharge of Qualified Principal Residence Indebtedness: Under Code Sec. 108(a)(1)(E), gross income does not include the discharge of indebtedness of a taxpayer if the debt discharged is qualified principal residence indebtedness and is discharged before January 1, 2026.

No Deduction for Mortgage Insurance Premiums as Qualified Residence Interest: Mortgage insurance premiums paid in 2023 are not deductible. Under Code Sec. 163(h)(3)(E), taxpayers could treat amounts paid before 2022 for qualified mortgage insurance as qualified residence interest, but this provision expired at the end of 2021.

Exclusion from Gross Income of Cancelled Qualified Real Property Business Indebtedness

Under Code Sec. 108(a)(1)(D), taxpayers can exclude from gross income a discharge of qualified real property business indebtedness which applies to real property used in a trade or business, such as a home office, and is secured by such real property and meets certain other qualifications.

Retirement Plan Contributions

Clients can save a lot on taxes by making the maximum contributions to a qualified retirement plan. Individuals under 50 years old who work for an employer that has a 401(k) plan can defer up to $22,500 of income into that plan for 2023. Catch-up contributions of $7,500 are allowed for individuals who are 50 or over. For a SIMPLE 401(k), the maximum pre-tax contribution for 2023 is $15,500. That amount increases to $19,000 for individuals 50 or older. The maximum IRA deductible contribution for 2023 is $6,500 and that amount increases to $7,500 for individuals 50 or over.

Observation: Beginning in 2024, the catch-up amounts will be indexed to inflation as a result of the SECURE 2.0 Act.

Charitable Contributions

With respect to charitable donations, clients may reap a larger tax benefit by donating appreciated assets, such as stock, to a charity. Generally, the higher the appreciated value of an asset, the bigger the potential value of the tax benefit. Donating appreciated assets not only entitles the taxpayer to a charitable contribution deduction but also avoids the capital gains tax that would otherwise be due if the taxpayer sold the stock.

For example, if a client owns stock with a fair market value of $1,000 that was purchased for $250 and the client's capital gains tax rate is 15 percent, the capital gains tax on the sale would be $113 ($750 gain x 15%). By donating that stock instead of selling it, a client in the 24 percent tax bracket has an ordinary income deduction worth $240 ($1,000 FMV x 24% tax rate). So the client saves the $113 in capital gains tax that would otherwise be generated on the sale of the stock and that amount goes to the charity instead. Thus, the after-tax cost of the gift of appreciated stock is $647 ($1,000 - $240 - $113) compared to the after-tax cost of a $1,000 cash donation which would be $760 ($1,000 - $240). However, it's important to also keep in mind that tax deductions for contributions of appreciated long-term capital gain property may be limited to a certain percentage of adjusted gross income depending on the amount of the contribution and the type of property contributed.

Additionally, a special provision allows taxpayers age 70 1/2 and older to make a charitable contribution of up to $100,000 directly from their IRAs to a charity. The SECURE 2.0 Act expanded this provision so that, beginning in 2023, such taxpayers may make a one-time, $50,000 distribution to a "split-interest entity" (i.e., a charitable gift annuity, charitable remainder unitrust, or charitable remainder annuity trust). Making a charitable contribution directly from an IRA has several benefits. First, since charitable contributions deductions are usually only available to individuals who itemize, a taxpayer who takes the standard deduction can benefit from this rule. Second, by making a contribution directly to a charity, the donation counts towards the taxpayer's required minimum distribution but that amount is not included in income and thus reduces taxable income and adjusted gross income (AGI). A lower AGI is advantageous because it increases the taxpayer's ability to take medical expense deductions that might not otherwise be available. In addition, the reduction in AGI decreases the amount of the taxpayer's social security income subject to income tax and possibly the 3.8 percent net investment income tax if the taxpayer has a lot of investment income.

Medical Expenses, Health Savings Accounts, and Flexible Savings Accounts

For 2023, medical expenses are deductible as an itemized deduction to the extent they exceed 7.5 percent of adjusted gross income. The threshold was permanently reduced from 10 percent to 7.5 percent by the Consolidated Appropriations Act, 2021.

To be deductible, medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. Thus, the cost of vitamins or a vacation taken to relieve stress and anxiety don't count, but hospitalization and long-term care expenses do qualify.

Deductible medical expenses include amounts paid for health insurance premiums, out-of-pocket costs for medicine, and amounts paid for transportation to get medical care. Deductible medical expenses also include amounts paid for personal protective equipment (e.g., masks, hand sanitizer and sanitizing wipes), amounts paid for qualified long-term care services, and premiums paid for a qualified long-term care insurance contract. Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, rehabilitative services, and maintenance and personal care services that are required by a chronically ill individual, and must be provided pursuant to a plan of care prescribed by a licensed health care practitioner. To be deductible as a medical expense, qualified long-term care insurance premiums must meet certain criteria (e.g., the contract must be guaranteed renewable) and the deduction for such premiums is limited to an amount that is based on the taxpayer's age before the close of the tax year.

Practitioners should consider whether it might be advantageous for a client, who has not already done so, to contribute to a health saving account (HSA) if he or she does not already have one. These tax-advantaged accounts can help an individual who has a high-deductible health plan (HDHPs) pay for medical expenses. Amounts contributed to an HSA are deductible in computing adjusted gross income. These contributions are deductible whether the client is itemizing deductions or not. Distributions from an HSA are tax free to the extent they are used to pay for qualified medical expenses (i.e., medical, dental, and vision expenses). For 2023, the annual contribution limits are $3,850 for an individual with self-only coverage and $7,750 for an individual with family coverage.

If a client works for an employer who offers a Flexible Spending Account (FSA), and the client has not already signed up for an FSA account, it's worth encouraging the client to do so. This will allow him or her to pay medical and dental bills with pre-tax money. And the FSA can be used to pay qualified expenses even if the employer or employee haven't yet placed the funds in the account. While FSA funds can be used to pay deductibles and copayments, they cannot be used for insurance premiums. The maximum amount that can be set aside in 2023 is $3,050. If the cafeteria plan permits the carryover of unused amounts, the maximum carryover amount is $610.

Premium Tax Credit

Code Sec. 36B provides a health insurance subsidy through a premium assistance credit for eligible individuals and families who purchase health insurance through the Health Insurance Marketplace, also known as the "Exchange." The provision is the result of the Patient Protection and Affordable Care Act (PPACA). The premium assistance credit is refundable and payable in advance directly to the insurer on the Exchange. In the past, individuals with incomes exceeding 400 percent of the poverty level were not eligible for these subsidies. However, as a result of the American Rescue Plan (ARP) Act and the Inflation Reduction Act of 2022, the cap is eliminated for tax years beginning after December 31, 2020, and before January 1, 2026, and therefore anyone can qualify for the subsidy for these years. In addition, the percentage of a person's income paid for a health insurance under a PPACA plan is limited to 8.5 percent of income. Thus, individuals who buy their own health insurance directly through the Exchange are eligible to receive increased tax credits to reduce their premiums.

Tax-Free Disaster Relief Payments under Section 139

On April 10, 2023, President Biden signed a resolution terminating the national emergency related to the COVID-19 pandemic. Under Code Sec. 139, a little-known or used provision, employers may be able to compensate employees tax-free for extra expenses incurred before April 10, 2023, due to COVID-19. This could include expenses incurred to set up a home office or to rent a place in which to quarantine or even for medical care. Under Code Sec. 139(a), gross income does not include any amount received by an individual as a qualified disaster relief payment. The term "qualified disaster relief payment" means any amount paid to or for the benefit of an individual:

(1) to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster;

(2) to reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or repair or replacement of its contents to the extent that the need for such repair, rehabilitation, or replacement, is attributable to a qualified disaster; or

(3) by a federal, state, or local government, or agency or instrumentality thereof, in connection with a qualified disaster in order to promote the general welfare.

In Rev. Rul. 2003-12, the IRS notes that Code Sec. 139 codifies (but does not supplant) the administrative general welfare exclusion with respect to certain disaster relief payments to individuals. According to the IRS, this exclusion from income applies only to the extent any expense compensated by such payment is not otherwise compensated for by insurance or otherwise. Additionally, qualified disaster relief payments do not include qualified wages paid by an employer, even those that are paid when an employee is not providing services.

The term "qualified disaster" includes a disaster determined by the President to warrant assistance by the federal government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. Since the COVID-19 pandemic was declared a national emergency under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, the provisions of Code Sec. 139 could apply to payments received by individuals from their employers to compensate the employee for additional expenses incurred as a result of the pandemic.

Education-Related Tax Items

There are several education-related tax deductions, credits, and exclusions from income that practitioners need to consider for clients who either attend, or have children who attend, eligible educational institutions.

Tax-Free Distributions from Qualified Tuition Programs: A Code Sec. 529 qualified tuition plan is a tax-advantaged investment vehicle designed to encourage saving for the future education expenses of the plan beneficiary. Tax-free distributions from a Code Sec. 529 qualified tuition program (QTP) of up to $10,000 are allowed for qualified higher education expenses. Qualified higher education expenses for this purpose include tuition expenses in connection with a designated beneficiary's enrollment or attendance at an elementary or secondary public, private, or religious school, i.e. kindergarten through grade 12. It also includes expenses for fees, books, supplies, and equipment required for the participation in certain apprenticeship programs and qualified education loan repayments in limited amounts. A special rule allows tax-free distributions to a sibling of a designated beneficiary (i.e., a brother, sister, stepbrother, or stepsister). As a result, a 529 account holder can make a student loan distribution to a sibling of the designated beneficiary without changing the designated beneficiary of the account. However, if the total QTP distributions to a designated beneficiary exceed the adjusted qualified higher education expenses of that beneficiary for the year, a portion of those distributions is taxable to the beneficiary. Code Sec. 529(c)(6) also provides that an additional 10 percent penalty tax generally applies to a taxable distribution from a QTP.

Deduction for Eligible Teacher Expenses: A deduction from gross income is available for eligible teacher expenses of up to $300 paid during 2023. If spouses are filing jointly and both were eligible educators, the maximum deduction on the joint return is $600. However, neither spouse can deduct more than $300 of his or her qualified expenses.

Exclusion from Income for Savings Bond Interest: If a client paid qualified higher education expenses during the tax year and also redeemed a qualified U.S. savings bond, the interest on the bond is excludible from income if the taxpayer's modified adjusted gross income level is below certain thresholds. The phaseout range for taxpayers filing as single or head-of-household is $91,850 to $106,850 and the phaseout range for taxpayers filing jointly or as a qualifying widow(er) is $137,800 to $167,800.

Education Credits: A client who pays qualified education expenses, and has modified adjusted gross income below $80,000 or $160,000 (for joint filers) may be eligible for an American Opportunity Tax Credit of up to $2,500 per year for each eligible student. Above those income thresholds, a partial credit may be available. The amount of the credit for each student is computed as 100 percent of the first $2,000 of qualified education expenses paid for the student and 25 percent of the next $2,000 of such expenses paid. Additionally, a Lifetime Learning credit may be available in an amount equal to 20 percent of so much of the qualified tuition and related expenses paid during the tax year (for education furnished during any academic period beginning in such tax year) as does not exceed $10,000. However, the expenses taken into account for this credit cannot be the same as expenses taken into account for the American Opportunity Tax Credit. The credit is phased out for taxpayers with modified adjusted gross income between $80,000 and $90,000 ($160,000 and $180,000 for joint filers).

Exclusion from Income for Repayment of Student Loan Debt: Under Code Sec. 108(f)(5), enacted by the American Rescue Plan Act of 2021, gross income does not include any amount which would otherwise be includible in gross income by reason of the discharge of a student loan occurring after December 31, 2020, and before January 1, 2026. Such loan forgiveness could, however, be subject to state and local income taxes.

Child-Related Credits and Exclusions from Income

Child Tax Credit: For 2023, a child tax credit of as much as a $2,000 is available for each child under age 17. In addition, a $500 nonrefundable credit is available for qualifying dependents other than qualifying children. Where the credit exceeds the maximum amount of tax due, it may be refundable. The maximum amount refundable for 2023 is $1,600 per qualifying child. The $500 credit applies to two categories of dependents: (1) qualifying children for whom a child tax credit is not allowed, and (2) qualifying relatives. The amount of the credit is reduced for taxpayers with modified adjusted income over $200,000 ($400,000 for married filing jointly) and eliminated in full for taxpayers with modified adjusted gross income over $240,000 ($440,000 for married filing jointly).

Dependent Care Credit: Payments to care for a child or another dependent so a taxpayer can work may be eligible for the child and dependent care credit. The credit is available to individuals who, in order to work or to look for work, have to pay for child care services for dependents under age 13. The credit is also available for amounts paid for the care of a spouse or a dependent of any age who is physically or mentally incapable of self-care. The credit is not available for amounts paid to a dependent or a taxpayer under age 19. The amount of the credit is a specified percentage of the taxpayer's total employment-related expenses. The specified percentage is 35 percent reduced (but not below 20 percent) by one percentage point for each $2,000 (or fraction thereof) by which the taxpayer's adjusted gross income for the tax year exceeds $15,000. Employment-related expenses incurred during any tax year which may be taken into account cannot exceed $3,000 for one qualifying individual or $6,000 for two or more qualifying individuals.

Adoption Credit and Exclusion from Income of Adoption Reimbursements: An adoption credit of $15,950 is available for the adoption of a special needs child as well as other children. The credit is available for each child adopted and is generally based on expenses expended in the adoption. However, the credit for the adoption of a special needs child is $15,950, regardless of the amount expended on the adoption. The available adoption credit begins to phase out for taxpayers with modified adjusted gross income in excess of $239,230 and is completely phased out for taxpayers with modified adjusted gross income of $279,230 or more. In addition, reimbursements of qualified adoption expenses or amounts paid by an employer for an adoption, up to $15,950, are excludible from income.

Alternative Minimum Tax

The odds of a taxpayer being hit with the alternative minimum tax (AMT) were greatly reduced with the enactment of the 2017 TCJA, which increased the AMT exemption and the AMT phase-out thresholds. However, it can still be an issue for higher-income clients. For 2023, the AMT exemption is $81,300 for a single filer, $126,500 for married filing jointly or surviving spouse, and $63,250 for married filing separately. The exemption begins to phase out by an amount equal to 25 percent of the amount by which alternative minimum taxable income exceeds $1,156,300 in the case of married individuals filing a joint return and surviving spouses and $578,150 in the case of unmarried individuals and married individuals filing separate returns. As a result, high-income taxpayers with household incomes above those thresholds, with large amounts of itemized deductions or significant AMT income from exercising stock options, could be at risk for the AMT.

If a taxpayer has a Schedule C business, allocating mortgage interest or property taxes to the taxpayer's Schedule C business can help prevent those amounts from being added back and increasing the taxpayer's AMTI.

Qualified Business Income Deduction

Under the qualified business income tax break in Code Sec. 199A, a 20 percent deduction is allowed against qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. The deduction is available to both itemizers and non-itemizers. The rules that apply to individuals with taxable income at or below $182,100 ($364,200 for joint filers; $182,100 for married individuals filing separately) are simpler and more permissive than the ones that apply above those thresholds. The deduction phases out entirely when taxable income exceeds $232,100 (single, head of household, and married filing separately) and $464,200 (joint filers). However, this deduction does not apply to a "specified service trade or business," which is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business.

Deductions for Excess Business Losses

Under Code Sec. 461(l), excess business losses of a noncorporate taxpayer are disallowed for tax years beginning after December 31, 2020, and before January 1, 2029. An excess business loss for the tax year is the excess of aggregate deductions attributable to a client's trades or businesses over the sum of aggregate gross income or gain plus a threshold amount. The threshold amount for 2023 is $289,000 or $578,000 for joint returns. Excess business losses that are disallowed are treated as a net operating loss carryover to the following tax year.

Life Events

For clients with divorces pending at the end of the year, practitioners may want to project the differences in a final tax bill based on filing a joint return or filing as married filing separately. For clients that divorced during the year, head of household filing status, with its increased standard deduction, is appropriate if the client has dependents living at home for more than half of the year and the client paid more than half of the upkeep of the home. For clients who will be changing their name as a result of a change in marital status, the Social Security Administration (SSA) must be notified. Similarly, the SSA should be notified for a dependent whose name has been changed. A mismatch between the name shown on the tax return and the SSA records can cause problems in the processing of tax returns and may even delay tax refunds.

On the other hand, if a spouse died during 2023, the client can still use married filing jointly as the filing status. While the year of death is the last year for which a joint return can be filed with a deceased spouse, the client may be eligible to use the head-of-household filing status for the following year or the year after that if he or she is considered a "surviving spouse." A surviving spouse is one (1) whose spouse died during either of the two tax years immediately preceding the tax year; and (2) who maintains as a home a household which constitutes for the tax year the principal place of abode (as a member of such household) of a dependent who is a son, stepson, daughter, or stepdaughter of the taxpayer, and with respect to whom the clients is entitled to a dependency exemption deduction for the years in which such exemption deductions are available. Even if the client does not qualify as a surviving spouse, he or she may nevertheless qualify as a head of household if the applicable requirements are met.

Clean Energy Credits

For individuals, clean energy tax credits are available for 2023. These credits include residential energy property credits (the nonbusiness energy property credit and the residential clean energy property credit) and vehicle-related credits (the new clean vehicle credit, the previously owned clean vehicle credit, and the alternative fuel refueling property credit).

Energy efficient home improvement credit. The energy efficient home improvement credit under Code Sec. 25C is a credit for 30 percent of the costs of all qualified energy efficiency improvements and residential energy property expenditures made during the year, subject to an annual limit of $1,200. There are also annual limits for specific types of qualifying improvements. The annual limits are: (1) $250 for any exterior door ($500 total for all exterior doors), (2) $600 for exterior windows and skylights, (3) $600 for other qualified energy property (including central air conditioners; electric panels and certain related equipment; natural gas, propane, or oil water heaters; oil furnaces; water boilers), and (4) a higher $2,000 annual limit for heat pumps and heat pump water heaters, biomass stoves, and boilers. A credit of up to $150 per year is also available for home energy audits. After December 31, 2023, a home energy audit must be conducted by a "qualified home energy auditor" (i.e., an auditor who is certified by a qualified certification program). However, under a transition rule for 2023, taxpayers can claim the credit for a home energy audit even if the auditor was not a qualified home energy auditor at the time of the home energy audit.

Residential clean energy credit. The residential clean energy credit under Code Sec. 25D equals 30 percent of the cost of certain qualified property installed on or used in connection with the taxpayer's home. Qualifying properties are: (1) solar electric property, (2) solar water heating property, (3) fuel cell property, (4) small wind energy property, (5) geothermal heat pump property, and (6) battery storage technology. There is no annual or lifetime limit on the residential clean energy credit except with respect to fuel cell property, which is limited to $500 for each half kilowatt of capacity. In addition, if more than one person lives in the home, the combined credit for all residents can't exceed $1,667 for each half kilowatt of fuel cell capacity.

Practice Tip: For both the energy efficient home improvement credit and the residential clean energy credit, if a taxpayer uses property solely for business purposes, the property will not qualify for the credit. A taxpayer who qualifies for the credits and whose use of the property for business purposes is not more than 20 percent may claim the full credit. For a taxpayer who otherwise qualifies for the credits, but whose use of the property for business purposes exceeds 20 percent, the amount of the credit is calculated by including only that portion of the expenditures for the property that are properly allocable to use for nonbusiness purposes.

Compliance Tip: The energy efficient home improvement credit and the residential clean energy credit are computed and reported on Form 5695, Residential Energy Credits.

New clean vehicle credit. Under Code Sec. 30D, a taxpayer who acquires a new clean vehicle assembled in North America is generally allowed a credit of up to $7,500 for the tax year the vehicle is placed in service (i.e., delivered to the taxpayer). For vehicles delivered on or after January 1, 2023, and before April 18, 2023, the total new clean vehicle credit equals a base amount of $2,500 plus, for a vehicle that draws propulsion energy from a battery with at least 7 kilowatt hours (kWh) of capacity, $417, plus an additional $417 for each kWh of battery capacity in excess of 5 kWh. For vehicles delivered on or after April 18, 2023, the credit amount equals $3,750 for vehicles meeting a critical minerals requirement plus $3,750 for vehicles meeting a battery component requirement. Price limits (i.e., MSRP limitations) apply depending on the vehicle type ($80,000 for vans, SUVs, and pickup trucks; $55,000 for other vehicles). The credit is also not available to taxpayers with adjusted gross income over $300,000 (married filing jointly), $225,000 (head of household), and $150,000 (single). Beginning in 2024, taxpayers will be able to transfer the new clean vehicle credit to the dealer and use the credit amount as a down payment at the time of sale.

Observation: The Department of Energy provides a list at FuelEconomy.gov of eligible clean vehicles that meet the requirements to claim the new clean vehicle credit, including the applicable MSRP limitation.

Previously-owned clean vehicle credit. Under Code Sec. 25E, a taxpayer who acquires a previously-owned clean vehicle is allowed a credit equal to the lesser of (1) $4,000, or (2) 30 percent of the cost of the vehicle for the year the taxpayer places the vehicle in service. In order to qualify for the credit, the vehicle must be sold by a dealer for a sale price not in excess of $25,000, and the sale must be the first transfer of the vehicle since August 16, 2022. In addition, the buyer must be an individual taxpayer who cannot be claimed as a dependent by another taxpayer who purchases the vehicle for use and not for resale and who has not been allowed the previously-owned clean vehicle credit in any of the 3 years preceding the sale of the vehicle. The credit is also not available to taxpayers with adjusted gross income over $150,000 (married filing jointly), $112,500 (head of household), and $75,000 (single). Beginning in 2024, taxpayers will be able to transfer the previously owned clean vehicle credit to the dealer and use the credit amount as a down payment at the time of sale.

Compliance Tip: The qualified plug-in electric drive motor vehicle credit is computed and reported on Form 8936, Qualified Plug-in Electric Drive Motor Vehicle Credit.

Alternative fuel vehicle refueling property credit. The alternative fuel vehicle refueling property credit under Code Sec. 30C is a credit for 30 percent of the cost of purchasing qualified alternative fuel vehicle refueling property. The credit allowed with respect to any single item of qualified alternative fuel vehicle refueling property placed in service by the taxpayer during the tax year cannot exceed (1) $100,000 in the case of depreciable property, and (2) $1,000 in any other case. In addition, the definition of qualifying property is expanded for years after 2022 to include bidirectional charging equipment and the credit can also be claimed for electric charging stations for two- and three-wheeled vehicles that are intended for use on public roads. Further, qualifying property must be located in an eligible census tract, which is either in a low-income community or not an urban area.

Compliance Tip: The alternative fuel vehicle refueling property credit is computed and reported on Form 8911, Alternative Fuel Vehicle Refueling Property Credit.

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