Tax Breaks for Gas Savers

Green could have a double meaning for environmentally conscious motorists at tax time. Buyers of an alternative-fuel vehicle could find themselves saving money at tax-filing time.

The Energy Policy Act of 2005 created a series of tax credits for four categories of fuel-efficient vehicles: advanced lean burn, fuel cell, alternative fuel and hybrid -- the most popular type and the one that offers the most credit opportunities.

Hybrids are the most popular type of energy-efficient vehicle, but several other automotive options can save gas and tax dollars.

An individual taxpayer who bought one of these alternative autos Jan. 1, 2007, or later in the year can file for the credit. Later, however, could mean less savings, depending on the type and make of vehicle purchased.

Following credit fluctuations

The credit was welcomed by taxpayers when it took effect last year. Previously, buyers of environmentally friendly autos received a deduction, which reduces taxable income and generally produces a lower tax bill.

With a credit, once you determine what you owe, the credit directly cuts your tax bill. It might even wipe out any taxes you owe. In essence, credits are more valuable tax breaks than deductions, since credits reduce your tax bill dollar for dollar.

However, the application of the new alternative-fuel vehicle credit is not as welcome for several reasons.

First, there is no set tax credit amount. The tax savings range from several thousand dollars to just a couple hundred. Precisely how much you can subtract from your final IRS bill depends on which eligible vehicle you buy.

In addition, the list of IRS-certified vehicles is not fixed. As automakers produce qualified vehicles, they will be added to the roll. So far, there are more than 40 hybrids and a handful of compressed natural gas vehicles that are credit qualified.

Finally, the credit amount of some alternative-fuel vehicles, notably hybrids, will be phased out and ultimately eliminated based on how many cars each automaker sells.

Limited-time offer

Once a manufacturer sells 60,000 hybrids, credits on all of its qualified vehicles will be gradually reduced and eventually eliminated.

Full credits for the company's cars will remain in effect for the next calendar quarter following the quarter in which its 60,000th vehicle is sold. For the subsequent two quarters, the incentive will be 50 percent of the full amount. For the two quarters after that, it will be 25 percent of the full amount.

After four quarters -- one year -- of reduced credits, the buyers of that automaker's energy-efficient vehicles will get no tax credit.

Essentially, makers of popular models will see the tax appeal of those autos dwindle and disappear long before the credit's scheduled Dec. 31, 2010, expiration date. That's already the case for Toyota. During the 2007 tax year, tax credits for all the Japanese automaker's hybrids, including its Lexus models, began phasing out and were eliminated on Oct. 1, 2007.

If you bought a Toyota or Lexus when credits were still available, the date of your purchase will determine just how large a tax credit you can claim on your 2007 tax return.

Necessary documentation

When you buy an eligible vehicle, the dealership should provide certification material that includes the maximum tax credit you can claim. In addition, the IRS issues announcements when vehicles meet the credit requirements and the credit amounts.

You'll need that amount, along with the date of purchase, to complete Form 8910, Alternative Motor Vehicle Credit.

The form is used by both individual and business owners of qualified vehicles. Part one of the form is filled out by both, part two applies to any business use of the vehicle, and part three deals with the auto's personal usage.

Be sure you follow line 3 instructions: Enter the maximum credit available for your particular vehicle. If you purchased a Toyota after its credit amount was reduced and enter that lower amount here, you'll cheat yourself. The reduced credit is taken care of on the next line, which asks for the percentage that the maximum is cut.

Some write-off restrictions

The tax credit also has a few other limits.

In addition to the requirement that the vehicle was put in service between Jan. 1, 2007, and Dec. 31, 2007, you can only claim the credit if you bought the auto. It's not available for leased vehicles, regardless of how energy efficient they are.

You also must be the vehicle's original purchaser. A pre-owned Prius may still save the ozone layer, but it won't save you any tax money.

The alternative vehicle credit also is nonrefundable. This means it can zero out your tax liability, but it won't help produce a tax refund for you. And you must count several other credits you claimed -- such as the foreign tax, child and dependent care, elderly and disabled, education, retirement savings, residential energy, and child tax credits -- before you can take the fuel-efficient vehicle break.

For example, say you owe the IRS $6,000 and your other combined credits of $4,000 take that bill down to $2,000. You bought a Prius last March, worth a $3,150 credit. Because you can only use the alternative vehicle credit to eliminate your tax bill, you effectively lose the excess $1,150.

Finally, the alternative motor vehicle credit doesn't apply to the alternative minimum tax. If you owe the IRS more money under that costly parallel tax system, you cannot use the automotive credit to reduce it. You can claim the alternative motor vehicle tax break only if your regular tax liability is greater than your AMT bill.