Don't Mess With Taxes

Gas prices went up again today. It's the 48th straight day they've increased, matching a record for this decade.

If that trend continues, some folks might be seriously thinking about buying a new, more fuel-efficient car.

What makes the option, even in a recession, more appealing is that there are some tax breaks associated with certain vehicle purchases.

And the IRS just improved one of those tax benefits that had been out of reach for some buyers.

The American Recovery and Reinvestment Act of 2009, aka the latest stimulus package signed into law on Feb. 17, includes a deduction for state and local sales and excise taxes paid on the purchase of new cars and other vehicles.

The deduction also covers taxes paid when you buy a new light truck, motor home or motorcycle. 

This tax break, as most do, also has some limits (which I'll get to later), but for most people, it is a welcome addition to the tax code. Unless you live in a place with no state sales tax.

The residents of Alaska, Delaware, Hawaii, Montana, New Hampshire and Oregon, however, have been feeling a a little bit cheated.

Not to worry. The folks at the IRS and Treasury Department put their heads together and decided that lawmakers really meant to give everyone, regardless of their state's lack of a sales tax, a more-or-less equal break. So the feds announced that the new vehicle deduction also is available in states that do not have a state sales tax.

Buyers of qualifying vehicles in no-sales-tax states will be able to deduct other fees or taxes imposed by their state or local governments. These fees or taxes 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.

"This special tax break is available for people purchasing a new car this year, and that can include people in states without a sales tax," said IRS Commissioner Doug Shulman in announcing the deduction interpretation. "This means that more people can take advantage of this deduction when they file their tax returns next year."

Other rules remain: Now about those limitations I mentioned earlier. While everyone now is a bit more pleased with the vehicle sales tax deduction, like almost every other tax, it has some limits.

Qualifying vehicles must be purchased between Feb. 17, the date the stimulus bill became law, and Dec. 31. If you bought a new auto in the first six or so weeks of the year, you are out of luck when it comes to this deduction, which you'll claim on your 2009 tax return that you file next year.

The amount of your deduction also is limited by the price of your vehicle. You can only count the taxes (or other eligible fees) paid on the first $49,500 of the purchase price of the vehicle.

Here in Austin, the sales tax is 8.25 percent (part of the price of not having an income tax in Texas). If the hubby and I bought the new $66,000 Mercedes we've been dreaming about, we wouldn't be able to deduct the entire tax amount. 

Rather, we could only count the tax on $49,500 of the vehicle's purchase price, or $4,084. 

Be sure to hang onto your auto sales documents that list the price of the vehicle and precise amount of tax paid. You'll need the information when you file.

And the amount of the deduction is phased out if your modified adjusted gross income (that's your AGI with some things added back in) is between $125,000 and $135,000 and you file as an individual taxpayer or between $250,000 and $260,000 and you and your spouse file a joint return.

Claiming the deduction: As I mentioned, you don't have to itemize to claim this tax break.

If you take the standard deduction, and most people do, you'll simply add the eligible tax to your standard deduction amount on your 2009 tax return.

For example, the standard deduction in 2009 for married couples is $11,400. If a couple pays 6 percent sales tax on a $30,000 car, they can add the $1,800 sales tax to the $11,400 and claim a standard deduction of $13,200.

If that couple is in the 25 percent tax bracket, that $1,800 deduction could be worth $450 in tax savings.

For folks who do itemize, if you you choose to deduct to deduct sales taxes instead of income taxes, you can claim your vehicle taxes on your Schedule A as part of your overall sales tax deduction.

Even better, in this case, you're not limited to the $49,500 purchase price cap or the income phase-out limits. You can deduct the full amount of the sales tax (to the extent that it does not exceed the general sales tax rate) either as part of your detailed listing of all our sales tax receipts or by adding the vehicular tax amount to the sales tax table for your state that the IRS provides.

Neither are you subject to the income limits that apply when the new vehicle tax deduction is claimed as part of the standard deduction.

Added tax benefits: If the high gas prices prompt you to buy a hybrid, remember that some of those vehicles also can get you a tax credit.

Toyota and Honda credits have disappeared and Ford's hybrid credit will phase out a bit more come Oct. 1, but full credit amounts remain for eligible GM and Chrysler vehicles. Not that Uncle Sam, majority shareholder in those last two U.S. car makers, has any preference. You do your homework and see which hybrid, with or without a credit (IRS keeps track of the qualifying makes and models), is best for your driving needs.

And you might also want to wait just a bit if you can. Tax Update Blog notes that Capitol Hill is exploring the possibility of even more auto purchase incentives via a "cash for clunkers" program.

Under one proposal, folks who traded in what the government deemed gas guzzlers would get vouchers of $3,500 or $4,500 to use toward the purchase of a new vehicle with better mileage.

If that idea does eventually make it into law, it looks like the latter part of 2009 might be a good time for you to visit whatever dealerships remain in your neighborhood and see what kind of sticker price and tax break deals you can get.