Are new car tax incentives worth it?

Situation: Car dealers are heavily promoting new car sales. Your client is thinking this might be the right time to buy and wants to know whether the tax incentives for buying a new car are worth it.

Solution: Purchasers of new cars, light trucks, motor homes and motorcycles will be allowed to deduct sales, local and excise taxes on their 2009 income tax returns. This is an above-the-line deduction, so you don’t have to itemize to claim it. To qualify, the vehicle must be new and purchased between Feb. 17 and Dec. 31.

Taxes on the purchase price of up to $49,500 qualify for the special deduction.

Assume you live in a state that charges 3% sales tax on the purchase of a new car and your car costs $40,000. You will be able to deduct $1,200 on Page 1 of your 2009 Internal Revenue Service Form 1040 when you file next year.

Remember, this is a deduction and not a credit. Thus, the tax benefit will depend upon your tax bracket.

The deduction phases out for single taxpayers with an adjusted gross income of more than $125,000, and married taxpayers whose AGI exceeds $250,000.

The deduction is not available for single individuals with AGI of $135,000 and married individuals with AGI of $265,000 or higher.

Bottom line: When negotiating your car purchase, remember that this incentive is nice, but it’s not the huge benefit that car dealers are promoting.
The IRS also offers tax credits for motor vehicle purchases.
The Alternative Fuel Motor Vehicle Credit was enacted by the Energy Policy Act of 2005 and includes separate credits for four distinct categories of vehicles:

1. Qualified hybrid vehicles
2. Qualified fuel cell vehicles
3. Qualified alternative-fuel motor vehicles (QAFMV) and heavy hybrids
4. Advanced lean-burn technology vehicles

The amount of the potential credit varies by type of vehicle and which of the four credits applies.

Hybrid vehicles use a combination of gasoline and electric engines. These vehicles have drive trains powered by an internal combustion engine and a rechargeable battery. Since hybrid vehicles are most common, the tax credit for qualified hybrids is explained here. For additional information regarding the other alternative motor vehicle credits, visit the IRS’s website at irs.gov.

The credit is available only to the original purchaser of a new qualifying vehicle. If the qualifying vehicle is leased, the credit is available only to the leasing company. The credits available in 2009 range from approximately $2,000 to $3,000.

Once 60,000 hybrid or clean-technology vehicles from a particular manufacturer are sold, the tax credit is reduced and eventually eliminated. The full credit can be claimed up to the end of the third month after the quarter in which the manufacturer sells the 60,000th hybrid vehicle.

The credit for qualified Toyota and Lexus vehicles was eliminated for purchases on or after Oct. 1, 2007. The credit for qualified Honda vehicles was eliminated after Dec. 31, 2008. To find out whether your car qualifies for the hybrid tax credit and the maximum amount of that credit, you can go to the IRS website and search for “qualified hybrid vehicles.”

Surprisingly, the credit is not available to reduce the alternative minimum tax liability. In addition, the credit is non-refundable, meaning you cannot reduce your regular income tax liability below zero with the credit.

If you are eligible for multiple tax credits, the hybrid tax credit is taken last after all the other credits (e.g., child care tax credit, mortgage credit, retirement savings credit) have been taken. Any tax liability left over by these reductions will be the maximum dollar limit of your hybrid tax credit. If your hybrid tax credit exceeds your maximum dollar limit, the excess is not refundable, and is lost forever. The excess cannot be carried over to another year, or given away to another person.

Bottom line: These credits are attractive, but somewhat limited, due to the increased sales of hybrid vehicles in the past few years. Several states allow hybrid car owners to use the high occupancy vehicle (HOV) lanes during rush hour. And this is a wonderful incentive.