by George G Jones and Mark A. Luscombe

Several tax provisions in the Internal Revenue Code, some of which have been around for nearly 10 years, have been designed to encourage the production and use of environmental-friendly vehicles.

Under Code Sec. 30, a 10 percent credit of up to $4,000 has been available for the cost of a qualified electric vehicle since 1993. Also since 1993, under Code Sec. 179A, an above-the-line deduction of up to $2,000 for the cost of an automobile, $5,000 for a truck or van weighing more than 10,000 pounds but not more than 26,000 pounds and $50,000 for a bus or a truck or van weighing more than 26,000 pounds, has been available for the purchase of qualified clean-fuel vehicle property.

A deduction is also provided in Code Sec. 179A for qualified clean-fuel vehicle refueling property. Qualified clean-fuel vehicle property can include either original equipment manufactured to use clean fuels or vehicles modified to use clean fuels. In either case, however, the deduction is only available to the original owner of the property. The deduction would not be available, therefore, to a taxpayer leasing the vehicle or purchasing a previously owned one.

Clean-burning fuels include natural gas, liquefied natural gas, liquefied petroleum gas, hydrogen, electricity and any other fuel at least 85 percent of which is methanol, ethanol, any other alcohol or ether.

Both the Code Sec. 30 credit and the Code Sec. 179A deduction were originally scheduled to start phasing down this year and disappear in 2005, but the Job Creation and Worker Assistance Act of 2002 that was passed earlier this year deferred the start of the phase down until 2004.

Under Code Sec. 280F, imposing limitations on the depreciation of automobiles, the cost of modifying a vehicle to utilize clean fuels is exempt from the Code Sec. 280F depreciation limitations, while the limits are tripled for a vehicle that is designed to be propelled primarily by electricity. These depreciation limits only apply to automobiles weighing 6,000 pounds or less, excluding many of the popular large sports utility vehicles.

The luxury automobile excise tax under Code Sec. 4001 provides higher cost limits before the tax applies (3 percent in 2002) for both Code Sec. 179A modified clean-fuel vehicles and vehicles built to be propelled primarily by electricity. Of course, this consideration will be irrelevant soon, since the luxury auto tax is scheduled to end after Dec. 31, 2002.

These environment-friendly provisions in the code have, up until this point, not been widely utilized. Electric-powered and natural gas-powered vehicles, although available, have not caught on in the consumer market. Even the Form 1040 does not highlight these provisions.

The clean-fuel deduction does not have its own line but, according to the instructions, must be written on the Add line for adjustments to gross income (Line 32 on the 2001 form). The credit also does not appear on Form 1040. According to the instructions you claim it on the Other Credits line by writing in Form "8834" and attaching that completed form (Line 50 on the 2001 form).

Hybrid vehicles

Now, however, car manufacturers are starting to make hybrid gasoline and electric vehicles that promise to be much more popular with consumers, especially if gasoline prices rise. In May of this year, the Internal Revenue Service announced a program to review and certify documentation by hybrid vehicle manufacturers with respect to the qualification of those vehicles for the Code Sec. 179A deduction.

The IRS has certified that three models of hybrid vehicles qualify for the $2,000 deduction. These are the Toyota Prius, certified by the IRS in August 2002 and the Honda Insight and Honda Civic Hybrid, which were both certified in September 2002. Other manufacturers also have hybrid vehicles in the works, but they have not yet received IRS certification.

The hybrid vehicles are priced at a point that the $2,000 deduction might well be enough to encourage many taxpayers to chose the hybrid vehicles for economic reasons alone, let alone environmental motivations. The Toyota Prius and Honda Insight models have been certified for the 2001, 2002 and 2003 model years; and the Honda Civic Hybrid for its new 2003 model. Taxpayers are, therefore, entitled to amend 2000 and 2001 tax returns to claim this deduction for certified hybrid models purchased in those years.

Business taxpayers

Hybrid vehicles are subject to the standard Code Sec. 280F depreciation limitations. Neither the special exemptions for modification costs nor the triple limits for electric vehicles are considered to apply to these hybrid vehicles.

Hybrid vehicles would qualify, however, along with all other vehicles that are subject to the Code Sec. 280F depreciation limitations, for the increase in the first-year depreciation limit from $3,060 to $7,660. This was enacted as part of the Job Creation and Worker Assistance Act of 2002. It was designed to enable business taxpayers to take advantage of the new 30-percent bonus depreciation that Congress hopes will help stimulate the economy.

While the $2,000 deduction under Code Sec. 179A would not be considered depreciation for purposes of the Code Sec. 280F depreciation limits, it would reduce the basis for purposes of calculating depreciation. The Code Sec. 179 expense election and the new Code Sec. 168(k) 30 percent bonus depreciation would be taken into account in determining the Code Sec. 280F depreciation limits.

Hybrid vehicles still qualify for the standard mileage rates for business travel (36.5 cents per mile in 2002 and 36 cents per mile in 2003) even though their actual cost of operation may be considerably less than standard automobiles.

Planning

Tax practitioners will want to make sure that their clients are aware of the tax benefits that are available to hybrid vehicle owners. They will particularly want to discuss with their clients the availability of the Code Sec. 179A deduction for certified model year 2001 or 2002 hybrid vehicles purchased in 2000 or 2001 and the possibility of amending returns to claim the deduction.

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