Congress Short-Circuits Hybrid Tax Credits—for Some

Do you remember how excited you were when you bought your hybrid last year? Savings at the pumps, clean emissions, cool technology—and a couple of thousand bucks snatched back from Uncle Sam’s fists. At least that’s what the salesperson promised, right? In most cases, the good folks at the IRS will deliver on that promise but—depending on what you bought—be prepared for a gotcha.

The Vanishing Toyota Tax Credit

Since the introduction of the 2004 Prius, Toyota has dominated the hybrid market, selling about 80 percent of the hybrids on the road. Apparently to prevent Toyota from running even further away with the hybrid market, the architects of the 2005 Energy Bill—the piece of legislation granting the hybrid tax credits—set a limit of 60,000 tax credits per carmaker.

Toyota hit that mark in June 2006. There’s a complex, multi-tiered phase-out period, but to keep it simple, here’s how it will affect your 2006 taxes:

  • If you bought a Prius before Oct. 1, 2006, you are entitled to the full tax credit of $3,150.
  • If you bought a Prius on or after Oct. 1, 2006, your tax credit is half that amount, or $1,575.

The tax credit is slowly vanishing for these Toyota and Lexus hybrids as well:

  • Toyota Highlander and Camry Hybrids
    Before Oct. 1: $2,600
    After Oct. 1: $1,300
  • Lexus RX 400h
    Before Oct. 1: $2,200
    After Oct. 1: $1,100
  • Lexus GS 450h
    Before Oct. 1: $1,550
    After Oct. 1: $775

No other carmaker reached the 60,000 cap in 2006, so qualifying buyers of non-Toyota hybrids will receive full credits. Honda is likely to reach the limit by the end of this year, and Ford by the end of 2008. General Motors and Nissan, the only other carmakers currently with hybrids in the American market, are a few years away.

See a complete list of hybrid tax credits.

The Other Shoe Drops

If that wasn’t complicated enough, brace for a bit more bad news from the taxman: Your hybrid vehicle tax credit will be substantially reduced or eliminated if you are subject to the Alternative Minimum Tax, or AMT.

The AMT dates back to the Tax Reform Act of 1969. The goal of the legislation was to prevent millionaires from exercising every possible credit and loophole, and thus entirely evading taxes. Sounds like a good idea? It was—back in 1969, at least, when $10,000 a year was a very nice wage and gasoline was 25 cents per gallon. However, because the rates were not adjusted for inflation, the AMT now affects more and more of the middle class as well as the rich. According to the New York Times, nearly 30 million taxpayers will be affected by 2010.

Unfortunately, many of the consumers most likely to buy a hybrid—prosperous but not ultra-wealthy families with kids and mortgages—are the most likely to pay the AMT.

A few AMT rules of thumb (but please consult your tax professional also):

  • If you owed AMT in the past, expect to pay it again.
  • The larger your family, the harder it is to escape the AMT.
  • Homeowners with incomes between $150,000 and $400,000 are very likely to be subject to AMT.
  • Residents of California, New York, and any other state that charges state income tax, are more likely to fall into the AMT bucket.

The exceptions:

  • Single people earning between about $25,000 and $115,000 should escape AMT, and therefore can still find the hybrid tax credit useful.
  • If your income is—ahem—$750,000 per year, then your taxes are likely to exceed the AMT. The hybrid tax credit would be allowable.

How will the Alternative Minimum Tax affect your hybrid tax credit? In simplest terms, you can’t get the full credit unless your regular tax obligation exceeds your AMT obligation by at least the amount of the credit. If you need more of an explanation, then it’s probably time to see your tax professional.

Did You Lease Your Hybrid? Foiled Again!

According to the IRS website, a consumer that leases a hybrid vehicle is not eligible for the credit. But wait—that’s not all. The vehicle must have been placed in service after Dec. 31, 2005, cannot have been used at the time of purchase, and must be driven predominantly within the United States.