Energy Law Offers Tax Breaks, but It’s Complex

Thinking about buying a hybrid car -- or installing new energy-efficient windows in your home? You might want to wait.

The energy bill signed into law last week will usher in lucrative tax breaks for buyers of fuel-efficient cars and energy-saving home improvements starting in January.

The catch is that it’s not always easy to figure out how much of a tax break you might receive. And if you wait too long, you might not get anything.

“This is something of a mess,” said Mark Luscombe, principal tax analyst with CCH Inc., a Riverwoods, Ill.-based publisher of tax information.

Added Eric Smith, an Internal Revenue Service spokesman, “There are a few complicating factors.”

Some of the biggest tax incentives are for buyers of hybrid cars -- which typically use both electric and gasoline power -- and “alternative fuel” vehicles. Current tax law provides these buyers with up to $2,000 in tax deductions. The new law will replace the deductions with tax credits that can reach $3,400.

Tax credits are significantly more valuable than deductions because deductions merely reduce the amount of income that’s subject to tax, but a credit reduces the tax owed on a dollar-for-dollar basis. Consequently, a $2,000 deduction saves a person in the 30% federal tax bracket $600 in taxes, and a $2,000 credit saves $2,000.

However, figuring how much of a credit a hybrid-car buyer might receive next year is a bit of a trick.

Under the new law, each hybrid car will qualify for two tax credits. The first credit is based on how many more miles the hybrid gets to the gallon than a similar standard-fuel vehicle.

Hybrids that are only 25% more fuel-efficient than a standard car will qualify for a $400 “fuel economy” credit. Those more than 50% more fuel-efficient qualify for an $800 credit, and those that are 250% more fuel-efficient will get a $2,400 credit.

A “conservation” credit is added on top of the fuel economy credit. This credit is aimed at providing a payback for the car’s lifetime fuel savings. This credit ranges from $250 to $1,000 per car.

Theoretically, a car that qualifies for the maximum of both credits would allow its buyer to cut his federal income tax bill by $3,400: $2,400 for the fuel economy credit plus $1,000 for the conservation credit.

Manufacturers, the IRS and possibly the Environmental Protection Agency are expected to work out the details on which cars get which level of tax breaks, manufacturers say. But no one is quite sure how much of a break any individual car will qualify for.

“We figure our cars will get in the neighborhood of $2,000 to $3,000 in tax credits,” said Nancy Hubbell, a spokeswoman for Toyota Motor Corp., which makes the nation’s bestselling hybrid, the Prius, as well as a hybrid Highlander and Lexus. “We can’t be more specific at this point.”

Honda Motor Co., which also manufactures three hybrids, also declined to speculate about how much each hybrid would win in tax credits.

“It’s a complicated formula based on what the fuel economy differential is between the hybrid and a comparable gasoline vehicle,” said Edward Cohen, vice president of government and industry relations for Honda. “But for some of these hybrids, there is no comparable vehicle.”

Ford Motor Co., which produces a hybrid Escape and is launching a Mercury hybrid, figures that its cars will qualify for $1,950 in tax credits.

But all the credits phase out once the manufacturer has sold a total of 60,000 cars. That’s a threshold Toyota expects to hit within four months after the provision goes into effect, but might take up to three years for Ford, which sells fewer hybrids.

There’s a brief window that will allow buyers to claim the full tax credits even after the manufacturer has exceeded 60,000 in hybrid sales. But once that window closes, buyers will get diminished tax breaks, if they get any at all.

The bottom line: Anyone who wants to buy a popular hybrid may need to act soon after the law goes into effect or risk losing out on the generous tax credits.

The law also provides a variety of tax breaks for buyers of fuel-cell, “lean-burn technology” and “alternative fuel” cars. However, few cars propelled by natural gas or clean-burning diesel are on the market today, manufacturers note.

There is one exception. Honda makes a natural-gas-burning Civic that’s expected to qualify for a $3,600 tax credit under the new law, Cohen said. These cars are not widely owned because natural gas refueling stations are few and far between, he added.

But Honda has started leasing its home refueling stations. These stations cost about $100 a month, but another set of new federal credits -- as well as state tax credits offered in California -- can reduce the net outlay to a few dollars a month. Cost for a fill-up: about $9, which will fuel the car for about 200 miles.

Homeowners who want to install energy-efficient improvements, including energy-efficient fan systems and geothermal heating and cooling systems, also will qualify for tax credits staring Jan. 1.

The most significant of these credits are for solar systems. The solar credits allow taxpayers to recoup up to 30% of the cost of purchase, assembly and installation of solar water heaters and photovoltaic equipment. But the maximum credit in any given year is capped at $2,000. And the credit is disallowed if the main purpose of the solar heater is to warm a swimming pool.

Other credits for home improvements are significantly less generous.

Those adding insulation to reduce heat loss, exterior windows or certain types of special heat-reducing roofing material can claim tax credits of up to 10% of the cost or $500, whichever is less. However, only $200 of the credit can apply to window purchases, and that $500 maximum is a lifetime limit.

Separate credits are available for those putting in central fan systems. These homeowners can claim a credit of up to $50. Those adding natural gas or propane water heaters can get credits of up to $150; those putting in electric or geothermal heating and air-conditioning systems can claim credits of up to $300.

One last caveat: The bulk of the home improvement credits expire in 2008.