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William Perez

Planning Ahead for the Hybrid Car Tax Credit

By December 1, 2005

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Dear Tax Guide, I'm thinking of buying a hybrid car next year. The model I'm thinking about looks like it will include a hybrid car tax credit of $3,150. So will this tax credit increase my refund, or does this tax credit not apply to me because I already get a refund?

Dear Reader,

Tax credits reduce tax liabilities. So many people mis-understand this. The reason you have been getting refunds is that your withholding and estimated tax payments have exceeded your tax liabilities. Having an additional tax credit, such as for buying a new hybrid car, will certainly boost your tax refund. But it may or may not boost your refund by the full amount of the tax credit, which you are estimating will be $3,150.

Let's give two examples to explain the concept. Joe is a salaried employee and earns $50,000 a year. His federal income tax withholding amounts to $8,595 for the whole year. (Let's also assume Joe is single with no kids.) I calculate a 2004 tax liability of $7,256 with no other deductions or credits. Based on this straightforward situation, Joe would have a refund of $1,339. (Tax liability minus withholding.)

Now, Joe is thinking about buying a hybrid car. The anticipated hybrid car tax credit will be $3,150. This tax credit first reduces Joe's tax liability (but not below zero). So Joe's tax liability is now $4,106. (Gross tax liability minus hybrid car tax credit.) This in turns boosts Joe's tax refund to $4,489. So it does look like the hybrid car tax credit increased Joe's refund. But it's really reducing his liability.

Mary, Joe's sister, is also thinking of buying a hybrid car. But Mary's tax liability is (let's say) $1,000. If she buys the same car with a $3,150 tax credit, only $1,000 of that tax credit will be applied to her taxes. The rest of the credit will sit unused. Yes, it will still boost her refund, but not as much. It would be better if Mary lets Joe buy the car, and Joe lets Mary use the car whenever she wants. Under the new tax law, Joe is prohibited from selling the car or giving the car to Mary (or to anyone else). The IRS will eventually clarify these rules, and will let people know how long they need to keep their car before re-selling it. Also, Joe still has a $4,106 tax liability, so if he buys two cars, this will reduce his tax another $3,150.

Anyone planning to buy a hybrid car should read my article on the hybrid tax credit, immediately.

July 4, 2006 at 1:10 pm
(1) duke says:

Finally I got response from IRS on tax credit. Mixed bag. Said I could NOT lower with holding in anticipation of 3150 credit. Only guidance on the whole affair is last years BUSINESS tax credit of which 2 pages apply to purchase. *It took a letter to Senator to pry this much out of the system* I fail to see reasoning behind this. I am tempted to sell a few shares of appreciated stocks to eat into this future refund. Or convert some IRA’s to Roths.

So far the Prius is a wonder car. First auto transmision that can shift better than I can. Other vehicle has burned less than ten gallons since we took delivery at end of Jan this year!

December 17, 2006 at 10:05 pm
(2) lavonne says:

Our taxes usually turn out that we break even, so how will this credit affect us, will we get it in full (3150) or what? thanks!

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