Ryan M. Messina

In 2010 the Obama administration implemented Internal Revenue Code Section 30D, a federal tax credit of up to $7,500 for all-electric and plug-in hybrid vehicles.  The administration implemented this act to help advance President Obama’s climate and clean energy goals, bring down costs for consumers, and incentivize car manufacturers to develop greater technological advancements.  The credit amount starts at $2,500 and varies based on the capacity of the battery used to power the vehicle.   Essentially, the better a companies’ technology, the greater the tax incentive for their customers.  Battery technology has advanced to a point that virtually all popular electric vehicle models now qualify for the $7,500 credit.

However, there are a few caveats.  The tax credit can only be used by individuals that owe the IRS at least the dollar amount of the credit, meaning that a taxpayer will not be eligible for a refund of the unused portion.  If a customer leases a qualifying vehicle, the tax credit will go to the car manufacturer that is offering the lease.  Most importantly, “[t]he credit begins to phase out for a manufacturer’s vehicles when at least 200,000 qualifying vehicles manufactured by that manufacturer have been sold for use in the United States.”  The phaseout period begins with the second calendar quarter following the calendar quarter which includes the first date on which the number of new qualified vehicles sold for use in the United States is at least 200,000.  After the phaseout has begun, there will be a fifty percent decrease of the credit for the first two calendar quarters of the phaseout period, an additional twenty-five percent decrease for the third and fourth calendar quarters of the phaseout period, and the credit will be eliminated for each calendar quarter thereafter.  This policy is based on the notion of economies of scale, meaning that the high initial cost of adding new technology to a vehicle will come down with increasing “scale” or quantity produced.

The predominant company that has exploited this tax credit is Tesla, Inc., a Delaware corporation headquartered in California.  Tesla was founded in 2003 to prove that “electric vehicles [could] be better, quicker and more fun to drive than gasoline cars.”  Under Chief Executive Officer Elon Musk’s leadership, Tesla’s stock price has grown from $17 per share on the date of its initial public offering in 2010, to nearly $380 per share at its height in 2018; with a corresponding growth in sales.  As of July 2018, Tesla announced that it had delivered its 200,000th vehicle within the United States.  These sales figures automatically triggered the phaseout provision of IRS Code Section 30D.  Specifically, Tesla customers would be able to take the full $7,500 tax credit if they purchased their vehicle by December 31, 2018, a $3,750 tax credit if they purchase their vehicle by June 30, 2019, a $1,875 tax credit if they purchase their vehicle by December 31, 2019, and will receive no tax credit if they purchase their vehicle as of January 1, 2020.

This phaseout of the electric vehicle tax credit is particularly burdensome for Musk’s stated goal of producing electric cars at prices affordable to the average consumer.  Tesla currently offers three vehicle models.  The Model S, currently priced at $84,750, the Model X, currently priced at $87,950, and the more affordable Model 3, which was planned to be priced at $35,000.  The problem is that Tesla builds tax incentives and gas savings into its pricing model which means that the loss of the tax credit will cause Tesla purchasers to pay substantially more for their car.  This is particularly problematic for Model 3 sales, which totaled 25,250 units in December 2018 alone and 141,546 in 2018 overall, far surpassing the highest previous sales of any electric car in a given year by 30,200 vehicles.

With Tesla’s goal of marketing the Model 3 in its attempt to attract non-luxury consumers, and with U. S. sales driven by Model 3 purchases, it remains to be seen whether the phaseout of the tax credit will adversely affect Tesla.  A price increase of $7,500 could prove fatal in Tesla’s attempt to sell to United States consumers with a household income averaging around $62,175.  It could also prove fatal for Tesla overall, which recently experienced a steep reduction of its stock price after a litany of troublesome events including Musk’s statement that he secured funding to take the company private, a criminal investigation into the statement by the Justice Department, and a civil investigation by the Securities and Exchange Commission (“SEC”).

Without admitting or denying the SEC’s allegations of securities fraud, Tesla and Musk have agreed to a settlement that required comprehensive corporate governance and other reforms, including Musk’s removal as Chairman of Tesla’s board and payment of financial penalties.  As a Delaware corporation, each member of Tesla’s board of directors, including Musk as CEO and controlling shareholder, owes the fundamental fiduciary duties of care and loyalty.  Under the duty of loyalty, Musk must “protect the interests of [Tesla] . . . [and] refrain from doing anything that would work injury to the corporation, or to deprive it of profit or advantage which his skill and ability might properly bring to it.”  Under the duty of care, Musk cannot make board decisions with “reckless indifference to or a deliberate disregard of the whole body of stockholders’ or actions which are without the bounds of reason.”

In October 2018, a shareholder derivative action, filed in Delaware’s Court of Chancery against Musk and other Tesla board members, alleged breaches of the fiduciary duty of loyalty, that Musk’s tweet was “materially false and misleading,” and that “[a]t no time did Tesla . . . have any disclosure controls or procedures in place whatsoever to assess whether the information []Musk disseminated via his Twitter account was required to be disclosed in reports Tesla files pursuant to the Securities Exchange Act of 1934.”  It is unclear what will result from this lawsuit or the other numerous securities class actions that have been filed against Musk and Tesla’s board of directors.  However, it is clear that Tesla’s board of directors need to enhance their oversight over Musk in order to ensure compliance with both the General Corporation Law of Delaware and federal securities law. 

Nevertheless, this incident pales in comparison to Tesla’s bigger problem: it’s $11 billion in long-term debt.  As of the last quarter in 2018, about $1.7 billion of Tesla’s long-term convertible debt was due within fourteen months, “meaning that the debt holders have the option of being repaid either in stock, at a specified price, or in cash.”  Some of that convertible debt has a conversion price far above Tesla’s current trading price, meaning that those debt holders will most likely want cash.

However, Tesla’s outlook is not completely grim.  Despite its financial difficulties, the market continues to admire Tesla’s cars.  “Tesla will have pre-orders for about 305,000 Model 3’s globally to fulfill in 2019,” estimated at 107,000 United States pre-orders and 198,000 pre-orders from outside the United States.  This indicates that global demand, which accounts for over fifty percent of Tesla’s sales and will not be affected by the loss of the U.S. tax credit, is also high.  Tesla, GM, and Nissan are currently lobbying congress to get the 200,000 vehicle cap lifted.  Additionally, Tesla plans to partially absorb the reduction of the federal tax credit by reducing the price of all its vehicle models—the Model S, Model X, and Model 3—in the United States by $2,000.

As one of the world’s most innovative companies, Tesla and its chief executive, should consider 2019 to be a crucial year for executing on its goals.  Time will tell if the loss of the electric vehicle tax credit will cause Tesla’s demise.  Nevertheless, the company still has close to a $50 billion market value and the leadership of Elon Musk, who has always found people willing to take a chance on him.

Ryan is a 2L regular division student at Widener University Delaware Law School and a member of The Delaware Journal of Corporate Law and the Moot Court Honor Society.  In 2018, Ryan received the E. Wallace Chadwick Memorial Scholarship—awarded annually to a law student who grew up in and maintains a substantial connection to Delaware County, Pennsylvania, and who has participated in community service.  Additionally, Ryan recently passed all four required sections of the Certified Public Accountant (CPA) exam.  Next year, Ryan will serve as the Journal’s External Managing Editor.

Suggested Citation: Ryan Messina, Will the Loss of the Electric Vehicle Tax Credit Lead to the Demise of Tesla?, Del. J. Corp. L. (Feb. 21, 2019), www.djcl.org/archives 6812.