The Energy Tax Incentives Act of 2005, passed as part of the 2005 Energy Act and signed by President Bush on Aug. 8, 2005, includes a series of new credits aimed at encouraging the purchase of various types of new alternative fuel vehicles.
The credits are available for vehicles placed in service starting Jan. 1, 2006. The credits have different sunset dates, but last at least through 2009. The existing deduction for clean-fuel vehicles, including hybrid vehicles, will expire at the end of 2005.
While in general the new credits appear to be more generous than the current deduction, taxpayers and their advisors will find that the generosity comes with some complexity. Each hybrid vehicle that was approved for the clean-fuel deduction qualified for the maximum $2,000 deduction, so the tax benefit was a constant in selecting among the hybrid models available.
The new credits will vary based on factors such as fuel economy, lifetime fuel savings and vehicle weight, and the tax credit for which any particular alternative fuel vehicle qualifies may differ from other alternative motor vehicles that the taxpayer is considering. Heavier hybrid sports utility vehicles fall under very different credit calculations than passenger vehicles and light trucks.
Also, the availability of some of the credits, including the one for hybrid vehicles, phases out once a manufacturer sells 60,000 units. Taxpayers who are looking at the more popular models in 2006 will want to move quickly or monitor the availability of the credit for the vehicle that they are considering purchasing.
Qualified hybrid credit
The credit focused on the most readily available alternative motor vehicles currently on the market is the qualified hybrid motor vehicle credit. This credit is composed of two parts: a fuel economy credit and a conservation credit.
The fuel economy credit is calculated based on a comparison of the vehicle's fuel economy with the 2002 model-year fuel economy for city driving. The fuel economy credit ranges from $400 for a vehicle with at least 25 percent better fuel economy than the 2002 base year, up to $2,400 for 250 percent better fuel economy than the 2002 base year.
The conservation credit is calculated based on the lifetime fuel savings of a vehicle. The credit ranges from $250 for a lifetime fuel savings of at least 1,200 gallons of gasoline, to $1,000 for a lifetime fuel savings of at least 3,000 gallons.
Together, these represent a maximum potential tax credit of $3,400. These credit limits are for a passenger automobile or light truck with a gross vehicle weight rating that is under 8,500 pounds.
For vehicles weighing over 8,500 pounds, there is a separate set of credit limits based on the incremental hybrid cost of the vehicle and a percentage allowance varying with the fuel economy of the vehicle.
There is a maximum credit for different weight levels, topping out at a credit of $30,000 for vehicles weighing more than 26,000 pounds.
For vehicles weighing less than 8,500 pounds, the credit expires at the end of 2010. For heavier vehicles, the credit expires at the end of 2009. Advanced lean-burn motor vehicles qualify for a credit similar to the hybrid credit.
Qualified alternative fuel credit
Vehicles operating on alternative fuels such as natural gas, liquefied natural gas, and liquefied petroleum gas can qualify for the new qualified alternative fuel motor vehicle credit.
Although a number of vehicles are on the market that would qualify for this credit, the current consumer market is somewhat limited by the lack of refueling resources to support these models. For a vehicle weighing not more that 8,500 pounds, the maximum credit would be $4,000. This credit expires at the end of 2010.
Fuel cell vehicles
Although the few fuel cell vehicles currently available are very expensive, the new law seeks to promote their further development by providing a credit that runs through 2014. The technology is based on hydrogen fuel cells and the credit is based on the vehicle's weight and fuel economy.
The credit for a vehicle weighing less than 8,500 pounds is $8,000, with a maximum supplemental credit based on fuel economy of $4,000.
Residential clean-fuel refueling equipment
For those taxpayers forging ahead to purchase an alternative motor vehicle without adequate refueling support, beginning in 2006 a credit of up to $1,000 will be available for the installation of alternative fuel vehicle refueling property at the taxpayer's residence. This credit expires at the end of 2010, or, for hydrogen fuel cell refueling, at the end of 2015.
Tax planning
The new alternative motor vehicle credits are in general more generous than the $2,000 clean-fuel vehicle deduction. Credits are, dollar for dollar, more valuable than deductions, and the dollar limits for the credits are potentially higher.
The 60,000-manufacturer-vehicle limit on the credit may mean that manufacturers of the more popular hybrid vehicles may see the eligibility of their vehicles for the credit start to phase out during 2006 and be gone for future years.
Once a manufacturer reaches 60,000 hybrid or lean-burn vehicles placed in service after 2005, the credit starts to phase down. It remains at the full credit for the quarter in which the 60,000-vehicle limit is reached and the following quarter. For the next two quarters, the credit drops to 50 percent of what it would otherwise have been. For the next two quarters after that, it drops to 25 percent, after which the credit disappears completely.
Taxpayers interested in the availability of the credit for Toyota or Honda hybrids, which already have an established market, may want to act as soon as possible to obtain their vehicles early in 2006. Given the waiting lists for some of these hybrid models, it may already be difficult to order certain hybrids with any certainty that they will still qualify for the credit once the vehicle is finally placed in service.
With the large number of hybrid sports utility vehicles scheduled to hit the market in the next few years, taxpayers should also be aware that vehicles having a gross vehicle weight of 8,500 pounds or more fall into a different credit computation formula.
Although the calculations for any particular alternative fuel vehicle appear complicated, it is likely that by 2006 tables will be available listing the amount of the credit for which any particular alternative motor vehicle qualifies, and taxpayers can do their comparison shopping with the tables in hand.
Taxpayers leasing hybrid vehicles are also eligible for the credit. The availability of the credit, therefore, need not necessarily influence the purchase or lease decision. The size of the credit, however, may be dependent on the term of the lease, as the Internal Revenue Service is authorized to issue recapture regulations that are likely to include amounts claimed under a lease that is shorter than the economic life of the vehicle.
These tax credits alone will in general not be the determining factor in pushing a taxpayer toward a hybrid or other alternative motor vehicle. Gasoline prices will be the driving factor in the growth of the alternative motor vehicle market.
Still, these credits will help ease the short-term financial costs of the move to alternative motor vehicles, and give many taxpayers the help to realize the potential long-term savings hoped for from these vehicles.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer Company.
