November 2005

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Updated, larger tax incentives for hybrid vehicles

For hybrid cars purchased through December 31, 2005, hybrid car buyers are allowed a $2,000 federal income tax deduction. This deduction was slated to diminish to $500 in 2006. But President Bush signed the Energy Policy Act of 2005 on August 8, 2005 which allows even larger tax incentives for new hybrid vehicles purchased beginning January 1, 2006. The new energy bill allows an estimated $250 to $3,400 federal tax credit depending on the model. A credit is much better than a deduction since a tax credit directly reduces taxes owed, as opposed to simply reducing taxable income.

Up from just three models in 2003, there are now ten models of hybrids offered in 2005 according to auto analysts J.D. Power & Associates. In 2006, there is expected to be 13. J.D. Power estimates that hybrid sales will account for just 1.51% of total vehicles sales in 2006.

The new tax credit is set to expire in 2009 but for many hybrid models, the incentive will end much sooner. Once an automaker has sold 60,000 hybrid vehicles, the tax credit for those automakers’ hybrids is slowly reduced over the next five consecutive quarters. For manufacturers like Toyota, which expects to sell 120,000+ hybrid vehicles in 2005, the tax credit could begin to be reduced as soon as fourth quarter of 2006. Other manufacturers may see their hybrid cars have the full tax credit for a longer period.

The credit amount is largely determined by a vehicle's city fuel economy relative to the average for its weight class, but vehicles that save at least 1200 gallons of fuel over their lifetime relative to the class average gain additional credits. Vehicles must also meet moderately stringent tailpipe emissions requirements to qualify. No diesel vehicle will achieve credits at the outset because automakers have yet to produce vehicles clean enough to meet those emissions requirements. This situation may begin to change in model year 2007, because ultra-low-sulfur diesel fuel will become widely available in late 2006, facilitating emissions reduction technologies for new diesel models.

You can calculate the hybrid car tax credit yourself using the tables in the energy bill. But some of the automakers’ specifications for 2006 models are not out yet. Currently, there are estimated calculations based on best-available information on The American Council for an Energy-Efficient Economy’s website (http://www.aceee.org/transportation/hybtaxcred.htm).

Colorado also offers a tax credit for purchasing a hybrid. The amount of the credit is based on air quality control commission regulations. The auto dealers should be able to tell you what the credit is for each model. For more information or to see the credits available for selected common vehicles, visit Colorado’s FYI Income 9 - Alternative Fuel Income Tax Credits. The largest credit listed is $4,713 for the 2005 Honda Insight (Automatic).

To the extent that the allowable credit exceeds the tax liability, the excess may be carried forward for up to five years.

The information presented in the Tax Newsletter is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly, cannot be regarded as legal or tax advice. Please contact your tax advisor for more information on the subject and how it pertains to your specific situation.

For more information
Here is a summary of hybrid and clean diesel federal tax credits for all years from HybridCars.com.

Check out Colorado's FYI Income 9 - Alternative Fuel Income Tax Credits.