You have to love car dealers. With the passage of the Energy Policy Act of 2005, car dealers are screaming about the tax benefits of buying these vehicles. Heres the scoop.

Deductions and Credits

The Energy Policy Act of 2005 made a major modification to the tax benefits of owning a hybrid vehicle in an effort to entice businesses and individuals to pursue cleaner fuel uses. The primary switch was to move the tax benefits from deductions to credits. Specifically, the Act creates a credit that can be claimed by taxpayers who purchase one of these super fuel efficient vehicles.

Taxpayers can now claim a credit of as much as $3,400 per vehicle. This is a HUGE tax break because credits are subtracted from the amount of tax you owe, not your gross income. If you can claim a credit of $3,400 and owe $5,000 after figuring your tax, you end up paying $1,600. Anyway you look at it, this is a very powerful tax savings benefit.

There are a few problems with the new credit for hybrid vehicles. First, the credits only apply to vehicle purchases beginning January 1, 2006. If you purchased in 2005, you get to claim a pitiful little deduction covered later on this page. Deductions have much less impact on your taxes since they are applied to gross earnings.

Second, the credit amount is not set regardless of what dealers or the media is saying. As of February 10, 2006, the IRS hasnt issued any guidance on the credit amount. When it does, the IRS will set a particular credit amount for each vehicle and model. In coming up with a figure, the IRS analyze how clean the vehicle is from an emissions point of view, the size and other things that a mechanic would understand. How an IRS agent understands these issues is beyond me, but such is life. Regardless, the IRS will be issuing the credit amounts for particular vehicles as we move through 2006.

If you purchased your hybrid in 2005, you do not get to claim a credit against the amount you owe Uncle Sam. Instead, you claim a deduction in the amount of $2,000 from your adjusted gross earnings. While this doesnt have nearly the impact of a credit, at least you get something.