New Rules Will Make Many Electric Cars Ineligible for Tax Credits

The Biden administration on Friday released new rules that will significantly shorten the list of electric vehicles that qualify for federal tax credits. Officials hope the change will push carmakers to move their supply chains out of China and to the United States or its allies.

The rules, issued by the Treasury Department, are a result of the Inflation Reduction Act, which Democrats passed last year to fight climate change by encouraging the use of zero-emission vehicles and green energy. The law also seeks to reduce the industry’s reliance on China, which makes most of the world’s batteries and dominates the processing of critical raw materials.

For purchases of their electric cars to qualify for up to $7,500 in tax credits, automakers must meet strict requirements for where they assemble the cars and batteries and where they get the materials that go into batteries. Only a handful of vehicles are expected to qualify for the full credit when the rules, which are more stringent than previous requirements, go into effect April 18, down from 21 now.

The new rules, which could be revised in response to comments from the public, will require that a certain percentage of the components and minerals in each electric car’s battery come from domestic sources or countries with which the United States has trade agreements.

The full list of qualifying cars will not be published for a couple of weeks, but Tesla has begun informing buyers that the changes would affect its lineup. The company said on its website that the least expensive version of its Model 3 sedan, one of the most popular electric cars, would no longer be eligible for the full credit. The car uses a battery made in China.

James M. Wickett, a partner at Hogan Lovells who focuses on tax and energy policy, said the electric vehicle tax credit was “moving supply chains, to the tune of tens of billions.”

“The details matter in a significant way,” he added.

One significant detail on Friday expanded the program to include battery minerals from Japan and paved the way for adding more countries, such as the 27 members of the European Union.

Officials in the United States, Europe and elsewhere have also begun discussing plans to build a kind of buyers’ club for critical minerals that could exert pressure over the global industry, including setting higher labor and environmental standards for mining, processing and manufacturing.

The race is on for manufacturers whose vehicles don’t qualify for the U.S. tax credits to procure the minerals and components that will satisfy the requirements. The credit awards a significant competitive advantage to any car that makes the grade.

To be eligible, at least 50 percent of the components in an electric car battery must be made in North America. And 40 percent of the minerals used to make the batteries, which often contain nickel, manganese and cobalt, must come from domestic sources or from countries that have trade agreements with the United States. The minerals quota will rise every year until it reaches 80 percent by 2027, and the component quota will climb to 100 percent in 2029.

The administration said it would later issue rules clarifying how much investment that companies could receive from countries like China and Russia and still qualify for tax credits. The law includes prohibitions on using critical minerals and battery components from a “foreign entity of concern,” a term that includes companies based in China, Russia, North Korea and Iran.

Some automakers have urged the administration to take a light touch, saying tougher restrictions could leave few cars eligible for tax credits.

In writing the rules, Biden officials have tried to balance two priorities: Encouraging Americans to buy cleaner cars to mitigate climate change, and trying to bring more factories for cars, batteries and battery materials to the United States and its allies.

Some consumers could decide to wait to buy an electric car until more vehicles become eligible for tax credits in a few years, said William Reinsch, the Scholl Chair in International Business at the Center for Strategic and International Studies, a Washington think tank.

“What always happens if people are uncertain is they hold on to their wallets,” Mr. Reinsch said.

The legislation has already shaken up the car industry. Immediately after President Biden signed the bill in August, a provision excluded from the tax credits any electric vehicles not made in the United States, Mexico or Canada.

Hyundai and Kia cars made in South Korea no longer qualified, angering that nation’s leaders, who felt betrayed by a close military and trade partner. Sales of South Korean-made electric vehicles have since lost market share in the United States.

The law also proved to be a major source of friction diplomatically. Leaders of the European Union, Japan and other U.S. allies feared the program would lure investment away from their countries or force them to offer more generous subsidies to compete with the United States.

Because the European Union, Japan and Britain do not have free-trade agreements with the United States, products from those countries, including battery materials, did not qualify for any portion of the tax credits.

Under pressure from foreign governments, the Biden administration proposed a workaround. In a news release, the Treasury Department said the law did not define the term “free trade agreement,” which “could include newly negotiated critical minerals agreements.” The Biden administration signed a limited trade deal with Japan on Tuesday covering critical minerals, and is negotiating a similar deal with the European Union.

But the strategy has brought on blistering criticisms from lawmakers in Congress, who have said the administration failed to consult with them on trade policy. Some lawmakers also argue that U.S. taxpayer money will now subsidize Japanese industry.

Senator Joe Manchin III of West Virginia, a pivotal player in the Inflation Reduction Act’s writing and passage, said in a statement that the Treasury Department’s guidance “completely ignores the intent” of the act. He urged the White House to “stop this now — just follow the law.”

“It is horrific that the administration continues to ignore the purpose of the law, which is to bring manufacturing back to America and ensure we have reliable and secure supply chains,” he said. “American tax dollars should not be used to support manufacturing jobs overseas.”

It is not clear how many vehicles will qualify for credits under the new rules.

At least some Tesla vehicles are likely to remain eligible. The company makes cars in California and Texas and batteries in Nevada. General Motors may also be able to qualify quickly because it has begun producing batteries in Ohio in a joint venture with LG Energy Solution.

Hybrid vehicles will qualify if they meet the other requirements and their batteries have a capacity of at least 7 kilowatt-hours.

Carmakers will have to certify whether their vehicles meet the components and minerals requirements. The Internal Revenue Service will enforce the rules. Some vehicles may qualify for only half the credit if, for example, they meet the component quotas but not the minerals quotas.

The list of eligible cars is expected to grow as it becomes easier for companies to buy processed lithium and other materials from U.S. trade partners like Canada and Australia. Numerous companies are developing mines and building refineries.

Hyundai is building a factory in Georgia, allowing the company’s cars to collect credits once production starts by 2025. Ford, Honda and many others are building battery plants in the United States.

And a loophole in the law allows companies to collect the credits if they lease vehicles to customers, even if the cars don’t meet sourcing and manufacturing requirements. In effect, people who lease electric vehicles could benefit from the credits indirectly if automakers and car dealers pass on the credit to them by requiring smaller monthly payments.

Alan Rappeport contributed reporting.