Tax credits for Tesla Model 3 and other EVs slashed starting next year

New rules proposed by the Department of Energy (DOE) may mean reduced or even no federal tax credit for electric vehicles made in North America if their batteries contain parts from places like China.

Broadly speaking, the federal EV tax credit is meant to make sure US automakers are sourcing battery components and materials from companies located in the US or US free-trade countries. To achieve these goals, DOE proposed new rules on Dec. 1 that said EVs with battery components coming from a company or group designated as a foreign entity of concern (FEOC) would be ineligible for the full tax credit. A company that had at least 25% ownership by a partner “owned by, controlled by, or subject to the jurisdiction or direction of a government” such as China, Russia, North Korea, or Iran is considered a FEOC.

The DOE’s proposed rules are set to apply to battery components on Jan. 1 next year, then will expand to include suppliers of battery materials in 2025. The DOE is accepting comments on its interpretation of the rules through Jan. 3.

The rules are already being felt weeks before the new year. Tesla (TSLA) noted on its website that its cheapest Model 3 sedans won’t be eligible for the full $7,500. “All new Model 3 vehicles currently qualify for a federal tax credit for eligible buyers. $7,500 tax credit will reduce to $3,750 for Model 3 Rear-Wheel Drive and Model 3 Long Range on Jan 1, 2024,” Tesla said on the Model 3 order page.

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“Currently, some of Tesla's vehicles use batteries from China, despite all their efforts to make batteries here in the US,” Canaccord Genuity analyst George Gianarikas said to Yahoo Finance. “They still use batteries we think [from] CATL in China.”

Ford’s (F) Mustang Mach-E may also be affected, as it will likely lose its credit of $3,500 next year. “Beginning Jan 1, 2024, the Mustang Mach-E may not be eligible for the current $3,750 federal tax credit. If you take delivery of a Mustang Mach-E by December 31, remaining 2023 models are still eligible for the federal tax incentive!” Ford said on the Mach-E order page. The Ford F-150 Lightning EV will still retain its full EV tax credit of $7,500, according to Ford's website.

A check by Yahoo Finance found that order pages for EVs like the Nissan Leaf EV and Volkswagen ID.4 also stated that buyers must “take delivery by December 31, 2023,” to qualify for the federal EV tax credit. Other EVs offered by GM and Rivian do not mention the loss of tax credits or having to take delivery by the end of the year. Currently, only 20 EVs on sale from Tesla, Ford, Nissan, GM, and Rivian qualify for federal EV tax credits, per the fueleconomy.gov website.

Despite the loss of tax credits in some instances, the Alliance for Automotive Innovation (AAI), a trade group representing many of the automakers, welcomed DOE’s guidance.

“When it comes to China and the auto industry, … it’s complicated, but this is important clarity,” AAI president John Bozzella said. “It’s important (for economic and national security) that the US controls its own destiny with supply chains and raw materials sourced domestically or from allies. That will happen. In fact, it’s already happening all over the Midwest and Southeast.”

As for Tesla, the loss of half the credit for the Model 3 RWD and all-wheel drive may impact sales in the near term, but shouldn’t be a huge concern for investors — it’s the bigger picture that matters.

“The lack of an incentive is potentially creating an ‘air pocket’ in the first quarter,” Canaccord's Gianarikas said, with the “air pocket” being a drop in sales for the Model 3.

“Maybe it means the fourth quarter estimates or actual volumes are really good because people rush to the store or rush online to buy their Tesla, leaving a little bit of an air pocket [in Q1]. We'll see how this all shakes out, but at the end of the day what really matters globally, is can Tesla sell 2.3 million plus or minus vehicles next year? We think the answer is 'yes.'”

Pras Subramanian is a reporter for Yahoo Finance. You can follow him on Twitter and on Instagram.

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