3 Money Reasons to Buy a New Car – Tax Deductions, Used CAR Trade-In Vouchers and Electric-Hybrid Credits

 car buyer tax break stimulusIf you are in the market to buy a new car or just looking for a reason to upgrade your existing car, then you could not have picked a better time than now. Apart from local and foreign automakers desperately cutting prices to stay in business or to revive flagging sales, the US government is doling out tons of free stimulus money and tax credits/deductions to entice new car purchases. I have written about the three main programs in detail, but here is a summary and ways you could take advantage of all three of these programs at the same time.

1. New Car State or Local Tax Deduction

This stimulus funded legislation provides tax breaks for new vehicle buyers by giving them a federal-income-tax deduction on local sales and excise taxes. It enables taxpayers to buy now and get cash back later on their 2009 tax returns (filed in 2010). The deduction is limited to the state and local sales and excise taxes paid on up to $49,500 of the purchase price of qualified new foreign or domestic cars, SUV’s, light trucks, motor homes or motorcycles that weigh no more than 8,500 pounds. You can still buy a qualifying vehicle for more than $49,500 (e.g. an $80,000 BMW), but you will only get a tax deduction up to the specified limit. The deduction is only available to families making less than $260,000 (or $135,000 for single filers). It is phased out for taxpayers whose modified adjusted gross income is between $125,000 and $135,000 for individual filers and between $250,000 and $260,000 for joint filers. Further, the new vehicle must be purchased on or after Feb. 17, 2009, and before Jan. 1, 2010, to qualify for the deduction.

Value of Credit: The average new car purchase price the first 11 months of last year was $28,280, and the average used car trade-in value was $15,203, according to data from the National Automobile Dealers Association. States typically tax the difference — $13,077 in this case. So a 5% sales tax rate would be $654, meaning the deduction would reduce taxable income that much. Each state has a different car sales tax, so the deduction will vary by state. For states that do not have state or local taxes on cars, the IRS recently ruled that buyers are entitled to deduct other fees or taxes imposed by the state or local government. The fees or taxes that qualify must be assessed on the purchase of the vehicle and must be based on the vehicle’s sales price or as a per unit fee.

2. Cash for Clunkers – Car Allowance Rebate System (CARS)

The Car Allowance Rebate System is a recently approved initiative that will help you pay for a new, more fuel efficient car or truck from a participating dealer when you trade in a less fuel efficient car or truck. Under this program, auto buyers will be entitled to discounts/vouchers of $3,500 or $4,500, based on the following criteria.

  • Tade-in cars must get no more than 18 miles per gallon, have been built in 1984 or after, and have been owned and insured by the purchaser for at least a year. A consumer could then get a $3,500 voucher toward a car that got at least 22 mpg. The value of the voucher will increase to $4,500 if the new car is 10 mpg higher than the trade-in. Consumers will also be able to use the vouchers toward the five-year lease of a vehicle.
  • A $3,500 voucher can go to a small light-duty truck that gets at least 18 mpg and is two mpg higher than the trade-in. A 4,500 voucher will be issued for a truck with a five mpg improvement.
  • A $3,500 voucher will be issued for large light-duty trucks that get at least 15 mpg and are one mpg higher than the trade-in. A $4,500 voucher will be issued for a truck with a two mpg improvement.
  • No trade in value: Because the old vehicle will be destroyed, the credit is given instead of the regular trade-in value — not in addition to it — though some dealers might compensate customers for the vehicles scrap value.

The vouchers under this program will be issued electronically to dealers almost immediately upon the point of sale, so the credit should be available at purchase. This program has limited funding of $1 billon (enough for about 250,000 consumers) and will likely expire by Nov 1, if not sooner. For more details, see the official government site cars.gov; and to determine if your car meets the fuel efficient requirements go to FuelEconomy.gov

3. Green Energy Car Credits

President Obama’s stimulus bill provides a modified credit for qualified plug-in electric drive vehicles purchased after Dec. 31, 2009. To qualify, vehicles must be newly purchased, have four or more wheels, have a gross vehicle weight rating of less than 14,000 pounds, and draw propulsion using a battery with at least four kilowatt hours that can be recharged from an external source of electricity. The minimum amount of the credit for qualified plug-in electric drive vehicles
is $2,500 and the credit tops out at $7,500, depending on the battery capacity. The full amount of the credit will be reduced with respect to a manufacturer’s vehicles after the manufacturer has sold at least 200,000 vehicles.

This credit is in addition to the Hybrid Auto Credit for vehicles purchased or placed into service after December 31, 2005 which may be eligible for a federal income tax credit of up to $3,400 (see IRS site for list of qualifying vehicles), Credit amounts begin to phase out for a given manufacturer once it has sold over 60,000 eligible vehicles.

Can I use the above credits together?

Yes. You can use the above credits together. For example, you can trade in your qualifying old car under the cash-for-clunkers program to get the discount voucher and also claim a deduction for the sales and excise taxes you pay on the new car. Here is a hypothetical example from a recent Vanguard article on this topic:

Johnny is currently driving a 1995 Dodge Caravan that has an estimated fuel economy rating of 17 miles per gallon. Because it has 90,000 miles and is in only fair condition, it has a trade-in value of $350, according to Kelley Blue Book. However, if he trades it for a 2009 Nissan Versa, which has an estimated 29 miles per gallon fuel economy rating, he would qualify for a $4,500 voucher because the new car’s rating is at least 10 miles per gallon more than the Caravan’s. That would reduce the cost of the new car from its manufacturer’s suggested retail price of $10,710 to $6,210.

In addition, because he earns less than $125,000 a year, Johnny can deduct the sales tax he pays on the vehicle from his federal income taxes next year. Finally, Johnny would save money on gasoline each week because of the greater fuel efficiency of his new car.

To get all the benefits you must still meet each of the individual program requirements and not claim the same tax break or deduction twice. Further, only one credit of each type may be issued for joint registered owners of a single eligible trade-in vehicle.

What’s the difference between a tax deduction and a credit?

Many of the tax breaks on new cars are either deductions or credits, and it is important to understand the difference. A tax deduction reduces the amount of income for which you are taxed. For example, if your taxable income were $50,000, a $2,000 deduction would reduce it to $48,000. So, you would pay taxes on an income of $48,000 instead of $50,000. This means your actual savings would be a fraction of the $2,000 deduction. A tax credit reduces the total amount of income tax you owe. So, if you owed $10,000 in federal income tax, a $2,000 credit would reduce the amount you owed to $8,000. With a credit, your actual savings would be $2,000

With all these “money” options, the car market is definitely a buyer’s paradise for now. Along with some research and strong bargaining at the dealership, new car buyers can easily save thousands on their next shiny new car. If you have any questions, leave a comment and I will try and get you a prompt answer.

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