New Tax Break Adds Appeal to Hybrids

By KATHY M. KRISTOF

Sept. 8, 2002 12 AM PT

TIMES STAFF WRITER

John Johnson just found another reason to love his Honda Insight. Besides great gas mileage and low emissions, the car may net him a $600 federal tax refund this year.

The Insight was one of three hybrid vehicles recently approved for a new tax break from the Internal Revenue Service.

“It’s great,” said Johnson, an Ann Arbor, Mich., engineer who maintains a Web site for Insight fans at www.Insightman.com. “With the deduction, the cost of these [hybrid] vehicles is getting into the range of an ordinary gas-powered car. I think the sales are likely to take off.”

Indeed, the combination of new technology and new tax breaks has created a lucrative opportunity this year for car buyers who opt to purchase a low-emission hybrid vehicle.

The IRS in the last month has approved three cars for a special $2,000 tax deduction: the Toyota Prius, a hybrid version of Honda’s popular Civic and the Insight, which Honda has said it may discontinue in about a year to make room for production of more Civics and other hybrids. The deduction can be applied against the car owner’s income for the year in which the car was purchased--even if that was as long as three years ago.

IRS officials won’t say whether they are considering additional cars for this deduction.

However, auto makers have become serious about pursuing this market. Last week, for example, longtime rivals Nissan Motor Co. and Toyota Motor Corp. agreed to a partnership aimed at creating 100,000 Nissan hybrids for the U.S. market. Ford Motor Co. and General Motors Corp. also are developing hybrid vehicles.

First Use of ’93 Law

The cars, which are powered by a combination of gasoline and electricity, are covered by a 1993 law offering tax deductions for “clean-fuel vehicles.” The law has been largely unused because it wasn’t clear which cars would qualify for the break. Auto makers began submitting product specifications to the IRS this year, after the agency clarified which types of models might qualify.

In August, the government announced that Toyota’s Prius would be the first model certified for the low-emission tax deduction. On Friday, the IRS also approved Honda’s two hybrid models. All three hybrids qualify for the full $2,000 deduction.

Other cars eventually may qualify for at least part of the deduction, which is intended to prod auto makers to produce cars that are more environmentally friendly and to encourage Americans to buy them. But to date, the IRS hasn’t named any other contenders.

The clean-fuel vehicle deduction is a so-called before-the-line write-off, which means it can be claimed regardless of whether you itemize deductions, reducing by $2,000 the amount of income that’s subject to taxation, said Jim Rivin, partner at Woodland Hills accounting firm Rivin, Wenzel & Co. That can save someone in the 31% tax bracket $620.

California does not offer a low-emissions deduction, so don’t try to claim this break on your state tax return.

Because this deduction reduces adjusted gross income, it also may help taxpayers claim other income-tested credits and deductions offered elsewhere in the federal tax code.

It’s tricky to claim, however, because there’s no specific line on the tax form for it, said Mark Luscombe, principal tax analyst with CCH Inc. in Riverwoods, Ill. Instead, taxpayers take this deduction by listing it with their other before-the-line write-offs, such as individual retirement account contributions and student loan interest deductions.

For example, on line 32 of the 2001 1040 form, taxpayers were asked to add together the before-the-line deductions listed on lines 23 to 31, Luscombe said. In the instructions for this line, the IRS notes that other before-the-line deductions that have no line of their own can be added there.

Taypayers who want to take this deduction should write “clean-fuel vehicle deduction” in the blank space on line 32, Luscombe said. And be sure to keep records of the car purchase, in case the deduction is questioned later.

The one-time deduction is claimed in the year the car was purchased. And the Prius and Insight models released in 2001, 2002 and 2003 qualify, officials said. (The Civic hybrid was just released.) However, those who bought hybrid vehicles in a previous tax year must file an amended tax return to claim it. To amend a return, the taxpayer must file a form 1040X for the applicable year.

Some Caveats

The deduction is temporary. It starts to phase out in the 2004 tax year, when the amount of the deduction will fall 25% to $1,500, said Jim Carlin, partner with Los Angeles tax law and accounting firm Holthouse Carlin & Van Trigt. The next year, it will fall to $1,000 and in 2006, the taxpayers will be able to deduct just $500, he said.

Moreover, taxpayers who resell their hybrid during the first three years of ownership must “recapture” all or a portion of the deduction, Carlin said. If the car is sold within a year of purchase, 100% of the deduction must be added to the taxpayer’s income for the year in which the car was sold; if it’s within two years, two-thirds of the amount previously deducted--or about $1,333--must be added back in. If the car is sold before it has been owned for three full years, the recapture equates to one-third of the previously claimed deduction.

Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof @latimes.com. For past Personal Finance columns, visit The Times’ Web site at www.latimes.com/perfin.

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Deductible Drives

Buyers of hybrid cars, which run on gasoline and electricity, can claim a $2,000 federal income tax deduction. Here’s a look at the three hybrids on the market.

Toyota Prius

Suggested retail price: $19,995

Mileage: 52 city, 45 highway

Sales: 1,900 a month

Honda Civic hybrid

Suggested retail price: $20,550

Mileage: 48 city, 47 highway

Sales: 1,800 a month

Honda Insight

Suggested retail price: $21,280

Mileage: 57 city, 56 highway

Sales: 400 a month