Federal Tax Incentives For Hybrid Cars And Alternative Motor Vehicles: It’s Time To Take A Second Look!

With gas prices increasingly on the rise, more consumers are considering hybrid cars as a viable option. And now, the IRS has expanded the list of models and upcoming models that will qualify for the tax credits, which took effect on January 1, 2006.

This article is a “refresher” on The Energy Policy Act of 2005, which replaced the clean-fuel burning deduction with a tax credit. For most hybrid car buyers, the new credits are more valuable than the previous federal tax incentives, which were reductions in taxable income instead of tax credits.

Background:

The Energy Policy Act of 2005 provides for a tax credit for certain fuel efficient vehicles.  The credit is available for vehicles purchased after January 1, 2006.  Qualifying vehicles includes each of the following defined categories:

1. “Hybrid” – Draws propulsion energy from both an internal combustion engine and a rechargeable energy system, and meets certain power and emissions standards
2. “Advanced Lean Burn Technology” – Certain diesel engines that meet prescribed fuel economy and emissions standards
3. “Fuel Cell” – Power is derived from one or more cells which convert chemical energy directly into electricity by combining oxygen with hydrogen fuel
4. “Clean Fuel” – The vehicle is only capable of operating on an alternative fuel -  compressed or liquefied natural gas, liquefied petroleum gas, hydrogen, or methanol (at least 85% by volume).

A credit is generally more advantageous than a deduction since it is subtracted dollar-for-dollar from your tax bill, while a deduction simply reduces taxable income.  The credit amount, which may be up to $3,400, depends on the fuel efficiency of the vehicle. The more gas it saves, the higher the credit. However, calculating the credit is a bit complicated, with the exact amount of the credit depending on three separate factors: the weight of the vehicle, its fuel economy, and its lifetime fuel savings. 

Here are some additional points about the credit:

• In general, the credit is allowed to the vehicle owner, including the lessor of a vehicle subject to a lease.
• For vehicles sold to tax-exempt entities, the seller of the vehicle qualifies for the credit, provided the amount of the credit is clearly disclosed to the user
• The credit is allowed in the year the vehicle is placed in service.
• A vehicle must be used predominantly in the U.S. to qualify for the credit.
• The credit isn't allowed for vehicles bought for resale.
• The amount of the credit is limited if any portion of the vehicle is depreciated or expensed using Code Sec. 179, the expensing election provision.  
• The credit is not allowed against the alternative minimum tax (AMT).

On January 13, 2006, the IRS provided guidance to the vehicle manufacturers (or, in the case of foreign vehicle manufacturers, their domestic distributors), with the issuance of Notice 2006-9.  This IRS publication instructs the manufacturers on how to obtain the necessary certification of qualifying vehicles, which will determine the amount and availability of the credit for the vehicle.  This guidance covers only the first two categories listed above: “hybrid” and “advanced lean burn technology” vehicles.  Future notices will be issued to address the other vehicles.  Additionally, future notices will address rules for which lessors may claim the credit, as well as the rule that the credit may not be used to reduce alternative minimum tax or may be recaptured.

The credit is set to expire at the end of 2010, but for many models the incentive will end much sooner.  That is because the law limits the credits to 60,000 vehicles from each automaker.  Once a manufacturer has sold 60,000 hybrid and advanced lean-burn vehicles, the tax credit for that manufacturer's vehicles is reduced over the next five consecutive quarters, eventually dropping to zero. Buyers have until September 30 to purchase one of the five gasoline-electric hybrid models sold by Toyota and Lexus to qualify for 100 percent of the credit.  On October 1, the credit amount will be reduced by half.  For other manufacturers, their cars will have the full tax credit for a longer period.

Recently, the IRS has ruled on exact credit amounts for certain hybrids and has posted a summary of the hybrid tax credits:

Model Year 2007

·         Chevrolet Silverado 2WD Hybrid Pickup Truck — $250

·         Chevrolet Silverado 4WD Hybrid Pickup Truck — $650

·         Ford Escape Hybrid 2WD — $2,600

·         Ford Escape Hybrid 4WD — $1,950

·         GMC Sierra 2WD Hybrid Pickup Truck — $250

·         GMC Sierra 4WD Hybrid Pickup Truck — $650

·         Lexus GS 450h — $1,550

·         Mercury Mariner 4WD Hybrid — $1,950

·         Saturn Vue Green Line — $650

·         Toyota Camry Hybrid — $2,600

Model Year 2006

·         Chevrolet Silverado 2WD Hybrid Pickup Truck — $250

·         Chevrolet Silverado 4WD Hybrid Pickup Truck — $650

·         Ford Escape Hybrid (Front) 2WD — $2,600

·         Ford Escape Hybrid 4WD — $1,950

·         GMC Sierra 2WD Hybrid Pickup Truck — $250

·         GMC Sierra 4WD Hybrid Pickup Truck — $650

·         Honda Accord Hybrid AT w/updated calibration and Navi AT w/updated calibration — $1,300*

·         Honda Civic Hybrid CVT — $2,100

·         Honda Insight CVT — $1,450

·         Lexus RX400h 2WD — $2,200

·         Lexus RX400h 4WD — $2,200

·         Mercury Mariner Hybrid 4WD — $1,950

·         Toyota Highlander 2WD Hybrid — $2,600

·         Toyota Highlander 4WD Hybrid — $2,600

·         Toyota Prius — $3,150

*2006 Honda Accord Hybrid AT and Navi AT without updated calibration qualify for a credit of $650.

Model Year 2005

·         Honda Accord Hybrid AT and Navi AT — $650

·         Honda Civic Hybrid MT and CVT — $1,700

·         Honda Insight CVT — $1,450 

·         Toyota Prius — $3,150

Any questions on the tax treatment for alternative motor vehicles can be directed to John Hayes or Dan Harcar at (216) 522-1231 or (216) 522-1008, respectively.

Note:  This is not intended to be specific legal or tax advice.  Please consult your tax advisor if specific tax advice is needed.  Additionally, we suggest that you and your employees DO NOT provide tax advice to your customers.  Your customers should consult their own tax advisor regarding expensing and tax issues.