Understanding 2006 Hybrid Car Tax Credits

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Think your hybrid only helps you save money at the pump? Your vehicle can also give you another break, a tax break. Tax day is once again looming on the horizon -- and, yes, it will be back again next year, too. Did you buy a new hybrid in 2006? Here's what you need to know about the IRS' new-for-2006 "Alternative Motor Vehicle Credit". Our explanation of the new credits and qualifications will help you take advantage of this new benefit and get the most out of your hybrid vehicle. We go to the trouble of decoding the tax lingo and translating the IRS's new articles and clauses into dollar signs. Out With the Old Under the Energy Act of 2005, a revised tax credit system for hybrid cars and light trucks was created. These policies went into effect in January 2006 and will be phased out and reevaluated again in 2010. Basically, the IRS is sweetening the deal for those thinking of buying more fuel-efficient vehicles Defining a Credit A credit directly reduces the tax you owe. You subtract the amount of the credit from your final tax bill. For example, If you earn $30,000 taxed at 10 percent, you owe $3,000. A $200 tax credit reduces your taxes to $2,800. Defining a Deduction A tax deduction is subtracted from your income before you calculate your taxes. It reduces your taxable income. For example, if you earn $30,000 taxed at 10 percent, you again owe $3,000. A $200 tax deduction reduces your taxable earnings to $29,800. This deduction saves you $20 and reduces your taxes to $2980. The outgoing hybrid clean fuel deduction allowed owners to deduct up to $2000 from their taxable income if they purchased a hybrid vehicle before the end of 2005. The new system works differently and allows owners to combine two different types of credits, ranging from $250 to $3,400, that are deducted from the final tax bill. The credit is void if your tax bill goes below zero. How It Works The burden rests on auto manufacturers to give the IRS certification that its hybrid vehicles qualify for credits. This is then passed from the manufacturer to the dealer to the customer. Under the new plan, only a finite number of vehicles qualify to receive the full credit. For example, Toyota sold 107,897 Priuses in 2005. Under the new tax rules, only the first 60,000 of Toyota's hybrid products sold are eligible for the full credit. After 60,000 of a specific hybrid model are sold, the tax credit becomes available at a reduced rate. For the six months after the 60,000th was sold, 50 percent of the credit amount is available. For the six months following that, 25 percent of the credit is available. After a year of reduced credits, the incentive will no longer be offered for that vehicle. Who Qualifies for What Along with the new system come new requirements. The exact amount of a specific credit is based on a complex formula determined by vehicle weight, type of hybrid technology, fuel economy, and emissions data. Basically, the combination of the following two factors is what largely determines how much your tax credit is. 1. Conservation Credit: A vehicle qualifies for a $250 credit if it is expected to save at least 1,200 gallons of gas over its lifetime (estimated by the IRS at 120,000 miles) compared to a fuel consumption average gathered from vehicles of similar weight and class. For each additional 600 gallons of gasoline savings, the vehicle earns $250 in tax credits, up to $1,000. 2. Fuel Economy Credit: This credit amount is also based on the vehicle's fuel economy compared to similar vehicles in its class. A $400 credit is awarded if the car or truck gets at least 25 percent better fuel economy. The credit increases by $400 for every 25 percent improvement after that, up to $2,400. The maximum combined credit is $3,400. The bottom line is you get more money for buying a more fuel-efficient car.