From The Tax Strategist, http://thetaxstrategist.net

The new hybrid-vehicle credit effectively replaces the clean-air deduction on the books the past several years. This deduction, set at $2,000 for 2005, was scheduled to be cut down to just $500 in 2006.

Instead, the new hybrid credit lets you keep as much as $3,400 in your pocket.

Advice: Make sure your clients understand all the tax ramifications. For more Information see the Tax Rules of the Road.

The whole story: Under the Energy Act of 2005, four credits are available for vehicles placed in service after 2005:

1. Qualified fuel-cell motor vehicle credit.
2. Advanced lean-burning technology vehicle credit.
3. Qualified hybrid motor vehicle credit.
4. Qualified alternative-fuel motor vehicle credit.

It’s expected that the hybrid motor vehicle credit will be the most popular of the four. The IRS must certify a particular make and model as being eligible for the credit.

How much is the hybrid vehicle credit? It can range from $400 to $3,400, although, currently, the highest credit for an existing vehicle tops out at $3,150 (see chart). The computation is a combination of the mileage a particular vehicle saves over 120,000 miles and its fuel economy expressed as a percentage of the 2002 model year fuel economy for its weight class. The better the car’s performance, the higher the credit.

Consult the chart below to find the credit amount for vehicles the IRS recently certified as meeting the required standards.

Note: The credit will gradually decrease for the most popular models. Reason: Congress set up the law so that the credit begins to phase out in the second calendar quarter after the calendar quarter in which the manufacturer has sold at least 60,000 of its qualified passenger automobiles and light trucks.

So far, Toyota is the only automaker affected by the phaseout. For a Camry Hybrid or Prius bought after Sept. 30, 2006, the credit drops to $1,575 and $1,300, respectively.

Those figures will remain in place for vehicles bought through March 31, 2007. After that, the amounts will drop again — to 25 percent of the original credit amount — before they completely disappear for vehicles bought after September 30, 2007.

Tip: Don’t bet against a change in the law, which now penalizes carmakers that offer the most energy-efficient choices.

Reprinted with permission from The Tax Strategist. For continuing advice on this and numerous other tax strategies, click here.

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