In late May, the Internal Revenue Service produced interim guidance in the form of Notice 2006-9, describing the new credit for qualified hybrid vehicles. Spawned by the Energy Policy Act of 2005, the credit replaces the $2,000 clean-fuel vehicle deduction that was available in previous years.A hybrid vehicle is defined as a vehicle that must have both an internal combustion or heat engine and a rechargeable energy storage system. There are also emission requirements for the vehicles. Only new hybrid vehicles purchased on or after Jan. 1, 2006, qualify for the credit, which is based on a two-pronged system that incorporates calculations based on the weight and the estimated lifetime fuel savings of the vehicle.

The one-time credit ranges from $250 to $3,150 per car. The car must be purchased for personal use or for lease. The IRS notice includes a list showing the specific credit for each vehicle (see "Qualifying Cars," page 16).

Consumer demand for hybrids is strong, and is fueled by the fact that the credit has a short life. The IRS has ordered that it be phased out as soon as a manufacturer has sold 60,000 hybrid vehicles to dealers. The rules for the credit provide for the following phase-out:

* 100 percent of the credit is available for vehicles purchased by the end of the first calendar quarter after the quarter in which the manufacturer sells its 60,000th hybrid.

* 50 percent of the credit is available for purchases in the second and third quarters after the quarter in which the 60,000th vehicle is sold.

* 25 percent of the credit is available for purchases in the fourth and fifth quarters.

* No credit is available thereafter.

Toyota filled its 60,000-vehicle allotment in May 2006, so purchases of Toyota hybrid vehicles, including the Lexus hybrids, qualify for 100 percent of the credit only through September 2006. A purchaser receives a certificate with the purchase that should be kept with tax records for the year in which the credit is claimed.

Gil Anderson, a salesman with Capitol Toyota in Salem, Ore., is convinced that plenty of people would buy hybrids with or without the credit, but thinks the credit is getting people in the door sooner. "Some people are buying the car for the tax credit, and they let you know it. Some people want the cars for their fuel efficiencies, and they don't even know about the tax credits. They're amazed by the fact that they get money back," he said. "It's a combination of the environment and fuel efficiency, and now the tax credit makes it more do-able, offsets the cost of the hybrid system."

Capital Toyota doesn't have any hybrids in stock - instead, it fulfills its waiting lists when cars become available. "We've never not had a list of people waiting," said Anderson.

Scott Becker, general manager at Ed Martin Honda in Indianapolis, said that customers who are interested in hybrid vehicles know all about the tax credit. "Customers are pretty informed about it," said Becker. "If they're interested in that, they've already talked to their accountant and are pretty much up to speed on that end of it."

But the story changes in some parts of the country. The desert Southwest is not the best place to get the most value out of a hybrid vehicle. "The hybrid component of the vehicle is dependant on the driver's use and location," explained Willy McCluskey, sales consultant at Sanderson Ford in Glendale, Ariz. "There are some tremendous benefits in the right location under the right conditions. When there are heat conditions where you have to use the air conditioning to stay in a comfortable environment while operating the vehicle, it diminishes the fuel efficiency of the vehicle because it then causes the engine to be operating," explained McCluskey.

The fine print

Customers who purchase hybrid vehicles must file IRS Form 8910, Alternative Motor Vehicle Credit, to take advantage of the new tax credit. Taxpayers subject to the alternative minimum tax might not see the full value of the credit on their returns. The Alternative Motor Vehicle Credit is to be taken last among a list of credits that includes the Child Tax Credit, the credit for dependent and child care, the Hope and Lifetime Learning tax credits, the Foreign Tax Credit, and others.

There is no carryover provision for the hybrid vehicle credit, so taxpayers whose tax liability is not sufficient to absorb the entire credit in the year in which the credit is earned lose any unused credit.

Customers also need to be aware of the fact that there is a recapture provision should the car be sold before the credit is fully earned.

STATES GET IN ON THE ACT

More than 20 states and cities across the country offer incentives for buyers of hybrid cars. From tax credits and rebates to free parking passes in city garages and the right to drive alone in high-occupancy-vehicle lanes, to exemptions from emission control inspections, there are benefits galore for both individuals and businesses.

See the latest list of state and local incentives online at www.hybridcars.com/incentives.html.

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