Tax breaks for gas savers

At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here’s an explanation for

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.

Options for alternative fuel vehicles:

  • Advanced lean burn technology vehicles have an internal combustion engine that incorporates direct injection and is designed to operate using more air than is necessary for complete combustion of the fuel.
  • Fuel cell vehicles are fueled by one or more cells that convert chemical energy directly into electricity by combining oxygen with hydrogen fuel.
  • Alternative-fuel vehicles run on compressed or liquefied natural gas, liquefied petroleum gas, hydrogen or any liquid that is at least 85 percent methanol.
  • Hybrid vehicles combine a gasoline combustion engine and a rechargeable electric energy storage system.
In this tax tip:
  • Fluctuations.
  • Limited offers.
  • Documentation.
  • Write-offs.

Individuals who buy an eligible alternative auto could take advantage of a nice tax credit. Just how much, however, depends on the type and make of vehicle purchased.

Following credit fluctuations

The tax credit was welcomed by taxpayers, who previously were allowed only a deduction for purchasing an environmentally friendly auto. A deduction reduces taxable income, which generally produces a lower tax bill.

But 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 as it might seem 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, is 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 the case for Toyota and Honda. Because the Japanese automakers sold so many hybrids, buyers of their fuel-efficient vehicles can no longer claim a credit for the purchase.

The only domestic auto maker to face phaseouts is Ford. Through March 31, the credit on its eligible hybrids is just 25 percent of the full amount. For vehicles purchased on or after April 1, buyers will get no tax credit.

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.

When you purchased and, in the IRS’ words, put the vehicle into service affect the amount of credit and in which tax year it can be claimed.

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 is nonrefundable. This means it can zero out your tax liability, but it won’t help produce a tax refund for you. You also 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 $500. You bought a hybrid worth a $1,000 credit. Because you can only use the alternative vehicle credit to eliminate your tax bill, you effectively lose the excess $500.

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.