Hybrid cars and the vanishing tax credit
Back in 2005, Congress enacted what looked like a generous tax subsidy for people who bought gas/electric hybrids and other alternative-fuel vehicles. Tax credits of up to $3,150 promised a dollar-for-dollar reduction in federal income-tax liability, though many consumers may now find themselves--or their vehicles--ineligible. The devil is in the details, and they can hit you on two fronts:
• The credits are gradually phasing out for the most popular models.
• People who are subject to the Alternative Minimum Tax (AMT) can’t claim the credit at all.
Disappearing act
The 2006 tax credit size depended on a vehicle’s estimated fuel economy. While a Toyota Prius was eligible for a credit of $3,150, a four-wheel-drive Ford Escape Hybrid qualified for only $1,950, and a two-wheel-drive Chevrolet Silverado Hybrid got only a token $250.
However, if a manufacturer--not just a brand--sells more than 60,000 hybrids total, the credit starts going away. The credit has already begun to phase out for Toyota and Lexus hybrids purchased after September 30, 2006, and others will follow suit as they reach the sales volume target. The 2006 Prius’ tax break, for instance, dropped in half to $1,575 if it was purchased after that date, and it will split again to $788 between April and the end of September, 2007. After that, the Prius rebate disappears altogether.
Adding up AMT impact
As mentioned, if you are subject to the federal Alternative Minimum Tax, or AMT, the news is worse because you don’t get the alternate motor vehicles tax credit at all.
The AMT was designed in 1969 to make the wealthiest taxpayers pay at least a little something in income tax. Since then, largely because inflation has marched on while the AMT has not, more and more taxpayers are snagged by the AMT dragnet every year. About 4 million people are expected to be affected by the AMT in this tax season (filing for 2006).
Bill Abrams, a principal at the Los Angeles law firm of Abrams Garfinkel Margolis and Bergson, LLP, explained how the AMT has snuck up on a lot of people in the last few years: “It’s worst on the East and West Coasts, where lots of people have high property taxes and state income taxes. The AMT effectively limits deductions for those things. So, the more taxes you’re already paying, the worse the bite from AMT.”
“For people in the middle of the country, these tax credits were terrific,” Abrams adds. “But the tax system has so many moving parts that you can’t really generalize about who benefits and who doesn’t.”
As incomes rise with inflation, more and more people have greater than $100,000 in adjusted gross income. Those who itemize their taxes are forced to calculate their taxes twice: once the traditional way and again using the more unforgiving AMT formula. For people with seven-figure incomes, though, the AMT doesn’t really matter because they’re already disqualified from many of the tax breaks extended to the middle and upper-middle class.
(To get a better idea of whether you'll owe the AMT, visit the IRS AMT Assistant.)
AMT in action
The alternative-fuel tax credit mirage tends to hit people on the bottom fringes of the AMT-eligibility scale. For example, take a hypothetical couple in Connecticut who have a joint income that just pushes them into AMT territory. They have three children, and qualify for deductions for their town real estate tax, state income tax, unreimbursed business expenses, and exemptions for the dependent children. In total they owe $32,000 in federal taxes, but $32,500 with the AMT.
If they had bought a hybrid vehicle in 2006 that carried a $3,000 tax credit, that would have theoretically reduced their federal tax to $29,000. Since the AMT disallows that credit, along with the state/local tax deductions and dependent exemptions, their tax owed remains at $32,500, which is $3,500 more than they’d owe if AMT hadn’t been a factor.
The bottom line
If you’re considering a hybrid or some other alternative-fuel vehicle because the federal tax credit makes it look financially appealing, you could be disappointed. And you may not know the real out-of-pocket cost until it’s too late, perhaps months after a purchase when you (or your tax preparer) can fully access your annual tax liability. The lesson here is to consult your accountant to confirm your eligibility for a federal tax incentive.
Learn more about taxes in the Consumer Reports Personal Finance section, as well as gain insights from the Consumer Reports Tax Blog.
