Tax Credits for Driving 'Green'

Dear Friends,
If you’re the typical American, you’ve been paying a lot of attention to what it costs to fill up at the gas pump. The good news is that this is costing less than it did a month ago. According to AAA, the average price per gallon of unleaded, nationwide, is $2.74 — down 8 cents from mid-September. Premium unleaded is selling for about 9 cents per gallon less — but still above $3 a gallon.

In other words, don’t break out the champagne yet.

Lulled into Complacency

It’s been nearly 30 years since America got serious about saving energy. The last major piece of legislation aimed at reducing our dependence on oil was passed in 1978 in response to the OPEC oil embargo of 1973-74. It included tax incentives for solar and wind-powered energy devices.

In case you’ve forgotten, we had a second OPEC crisis in 1981 that sent gas prices skyrocketing once again.

Then OPEC got its act together and oil prices steadily declined. Predictably, so did our interest in conservation and alternative energy. The 1990s ushered in ever-larger pick-up trucks and gas-hungry SUVs, epitomized by the 8-mile-per-gallon Hummer.

It may seem like a distant memory, but at the end of March 1999, the average price of a gallon of unleaded regular (including taxes) was 91.3 cents — the lowest level, adjusted for inflation, that the country had ever seen, according to the non-profit group Resources for the Future. Cheaper than the inflation-adjusted price of gasoline during the Great Depression or either of the OPEC-induced crises.

As we are all too painfully aware, this couldn’t last for long. While many experts are predicting the price of crude will eventually stabilize at $35-$45 per barrel, no one expects it to fall back to $15-$20 a barrel. (Mention $9 a barrel — believe it or not, the price of oil in March 1999 — and you’ll get laughed out of the room.)

The problem is that our suburban-oriented society is based on having your own vehicle. Make that [multiple] vehicles. There’s dad’s, mom’s, and probably one for each kid with a driver’s license. In all but a handful of cities, you can’t get to work, the grocery store, soccer practice, or the doctor without some type of personal transportation. So unless you’re willing to jump on a bicycle, you’re probably wistfully eyeing those hybrids in dealer showrooms.

The good news is that for a limited time, the federal government is going to give you a significant tax break if you make the switch.

Tax Credits for Energy-Efficient Vehicles

Under the “Energy Tax Incentives Act of 2005” you can get a tax credit of as much as $3,000 for buying an energy-efficient car or truck. As I described last week, there are also tax savings for upgrading the appliances and heating systems in your home with ones that use less energy.

The vehicle tax credit is only available if you purchase a “qualified” vehicle. This [credit] replaces the $2,000 tax deduction you get if you buy a hybrid or other fuel-efficient vehicle through Dec. 31 of this year.

I know what you’re thinking: which is better, the tax deduction or the tax credit? I asked a couple of CPAs the same question and got the same answer: “It depends.” There are so many factors that affect this calculation (income level, tax bracket, the amount of the credit, etc.) that it’s impossible to answer without running the numbers. Nancy Faulssett, a CPA with BNA Software, says “A credit could be worth more or less than a deduction. However, if you’re in a high tax bracket, dollar for dollar, getting the credit is going to be very valuable.”

Tax credits are available for four categories of vehicles, depending upon the type of engine and fuel required. This includes:

1. Hybrids;

2. Those using “lean burn” technology (a.k.a. “cleaner burning diesels;”

3. Those using alternative fuels;

4. Vehicles using fuel cells.

The amount of the credit depends upon the vehicle you buy and is made up of two factors: a) the fuel economy of the car/truck compared to a 2002 vehicle in the same weight class; and b) the estimated fuel the vehicle will save over its lifetime. The vehicle must also meet tailpipe emission requirements.

A piece of advice: don’t even try to calculate the credit yourself. “It’s much too complicated to figure this out,” says Faulssett. Terese Langer, transportation director of the American Council for an Energy-Efficient Economy (ACEEE), agrees, saying “There’s no reason why the manufacturer shouldn’t have that number right on the nose.”

At this point, only eight models are currently available to American consumers, with Japanese automakers Toyota and Honda leading the pack. Ford and Chevrolet each offer one model (OK, two if you count the two- and four-wheel drive versions of the same model separately). All are hybrids except the Honda Civic GX, which runs on natural gas.

Based on preliminary data about 2006 models ACEEE has estimated the tax credits for 32 vehicles that potentially qualify for the tax credit. You can access this at:

Diesel aficionados will be disappointed: while the cars and trucks listed use less fuel, they are still too “dirty” to pass the emissions test. As a result, not a single diesel-powered vehicle qualifies for the tax credit. However, ACEEE points out this could change by 2007 when “ultra-low-sulfur diesel fuel” will be widely available.

Timing is Everything!

There’s a limit to the government’s generosity. Only 60,000 vehicles per manufacturer — not per model — are eligible for the full credit. Once the 60,000th vehicle is sold, the credit begins to phase out.

Some automakers could hit this milestone early in the year. For instance, this year Toyota is expected to sell 100,000 Prius models — an average of 25,000 vehicles per quarter. When you add in sales of its other hybrids, Toyota could conceivably hit the 60,000 mark in the first quarter of next year.

Why the limit? According to ACEEE’s Langer, the short answer is “Money and politics.” The government wanted to keep the cost down (tax credits mean less money going to the U.S. Treasury) and also help U.S. automakers catch up with the Japanese. “In the beginning there was no limit,” says Langer. “Then it became clear that since foreign manufacturers had the lead on hybrids, Detroit would be at a disadvantage.”

How will a consumer know whether they’re buyer vehicle number 60,000 or number 60,001?

Fortunately, you don’t have to be that precise. Auto manufacturers will be required to keep track of the qualified vehicles they sell. According to George Jones of CCH, “There’s a little time to sort it out because there’s no reduction in the same quarter the 60,000th sale is reached.” In fact, buyers will still get 100 percent of the credit through the end of the following quarter.

For instance, say Toyota sells 60,000 qualifying vehicles by mid-March 2006. Additional Toyota buyers will still receive the full tax credit through June 30. For the next six months (i.e. starting July 1), the credit is reduced by 50 percent. During the next two quarters, or six months (i.e. starting Jan. 1, 2007 in this example) it’s reduced to 25 percent. After that the credit disappears.

The point is, be sure to ask the dealer whether the car you’re buying qualifies for the full credit or just a partial one.

The I.R.S. has to work out the details on how this program will be tracked and enforced, so some things are still a little fuzzy at this point. For instance, according to an aide on the House Ways and Means Committee, “The intent of the law is that the sale from the manufacturer isn’t complete until the end user gets possession.” What constitutes “possession?” Is the sale complete when you sign your paperwork or when you actually pick up your vehicle? Stay tuned.

Getting the Credit

If you’re in the market for a fuel-efficient vehicle, particularly if it’s a popular model, consider visiting a dealer later this year or first thing next year. Make it clear that you are not prepared to sign a contract or take possession until 2006. Even if you have to get on a waiting list, there’s a good chance you’ll qualify for the full tax credit if the manufacturer reaches the 60,000th vehicle level within the first 6 months of next year.

If you don’t go car-buying until next year, be sure to ask the dealer whether the manufacturer has reached –- or is close to reaching —the 60,000 vehicle mark.

Finally, rest assured auto manufacturers have gotten the message: more energy-efficient vehicles are on the way. According to ACEEE’s Langer, “There are going to be lots of new models in the next year or two. There should be something for everyone.”

Hope this helps,


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