How AFV Tax Credits Work


Image Gallery: Alternative Fuel Vehicles A natural-gas powered Ford C-Max is displayed at an auto show in Frankfurt. Some natural gas vehicles could qualify for AFV tax credits. See more pictures of alternative fuel vehicles.
John MacDougall/AFP/Getty Images

Pssst. . .the government is trying to control your behavior. Don't grab your tinfoil hat, it's less nefarious than it sounds. Governments often use taxes to change how their citizens behave and promote the greater good. For example, the U.S. government puts a high import tax on steel to encourage the use of U.S.-made steel. Cigarettes are taxed to discourage people from smoking. There's even talk about taxing junk food to nudge people into improving their eating habits and combating obesity.

Those kinds of taxes are used to discourage behavior, but the government can also use taxes to promote behavior. By offering breaks, like tax credits or tax deductions, the government gives people a financial incentive for certain choices. The most famous way the U.S. government does this is by offering tax credits for homeowners. Homeownership is good for the country because it builds wealth and keeps people invested in the places they live. The government encourages homeownership by letting homeowners deduct certain things to save on their taxes, like the interest they've paid on their mortgage.

The government also wouldn't mind if you helped cut pollution and eased the country's dependence on oil. To get you to do that, its offering tax credits on alternate fuel vehicles, or AFVs.

What's an AFV and what will the government do for you if you buy one? Read on to find out.

Alternative Fuel Vehicle Tax Credits

The Honda Civic GX runs on natural gas as well as other alternative fuels.
The Honda Civic GX runs on natural gas as well as other alternative fuels.
Karen Bleier/AFP/Getty Images

If you want in on AFV tax breaks, you need to know what one is. An AFV is a vehicle that runs on fuel that isn't gasoline or diesel. The government recognizes four types of fuel for AFV tax credits:

You've probably noticed that there aren't a lot of cars at your local dealership that run on these fuels. In fact, you're not likely to find any. The Environmental Protection Agency (EPA) lists only one current car model that runs on any of these fuels: the Honda Civic GX [source: EPA].

Still, there are a lot of cars you can buy that will qualify you for tax credits. Though hybrid cars aren't technically AFVs, buying one can still qualify you for some tax breaks. Most major car manufactures offer at least one hybrid model. Though hybrids tend to cost more than gas-only cars, the savings on taxes (and gas) just might be worth it.

But why do hybrids and AFVs earn their drivers tax breaks? Like we mentioned before, the government wants to encourage people to buy them. Vehicles that run on alternative fuel sources cut down on pollution. They also cut down on the amount of oil the country uses, which helps keep prices low and means that we're better able to withstand a catastrophe that interrupts the supply of oil. (Remember when oil refineries were knocked offline after Hurricane Katrina?)

The U.S. government codified the incentives to buy cars that use less oil in the Energy Policy Act of 2005. It covers not only car purchases, but also encourages people to buy more energy-efficient appliances.

All right, enough with the background. On the next page, we'll get to the good stuff. How much money is the government is willing to take off your tax bill, and what you need to do to qualify?

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What are the Tax Credits?

Honda and Toyota hybrids have sold successfully.
Honda and Toyota hybrids have sold successfully.
Stan Honda/AFP/Getty Images

Under the Energy Policy Act of 2005, the tax credit you get depends on the type of vehicle you buy. But a few rules apply to all hybrids and AFVs:

  • You must be the original owner of the car. A used car doesn't count.
  • You must buy the car to use it -- not to resell it. (Otherwise people could just flip cars for the tax credit.)
  • The car must be used in the U.S.
  • You need to buy and start using the car between Jan. 1, 2005, and Dec. 31, 2010. (That means that if you bought a hybrid or AFV a while ago and never claimed the credit, you can file an amended tax return and maybe get a refund.)
  • You need to submit IRS form 8910.

If you buy an AFV and meet the criteria above, you qualify for a $4,000 tax credit [source: EPA]. If you have an AFV that you bought and started using before Jan. 1, 2005, you still may be able to get a $2,000 tax deduction [source: EPA].

Hybrid tax credits and other incentives are a little more difficult to calculate. That's because the government not only wants you to buy hybrids, but also wants to encourage carmakers to produce them. After a company has sold 60,000 hybrid models, the tax credits start to phase out. That means that if you're considering a hybrid, it may pay to go with a carmaker that's new to the hybrid game. Right now the only carmakers that have had the phase-outs begin on their vehicles are Honda and Toyota.

The tax credits for buying a hybrid aren't as great as for AFVs. That's because hybrids still use gas -- they just don't use as much as regular cars. Hybrid tax credits are also based on how fuel-efficient the hybrid is. For example, a two-wheel drive Ford Escape Hybrid gets a larger credit than a four-wheel drive Ford Escape Hybrid because the four-wheel drive system adds weight, which increases the car's gas consumption.

While hybrids that meet the criteria above are eligible for a tax credit of up to $3,400, most aren't efficient enough to qualify for the full amount (the Toyota Prius comes the closest, qualifying for a $3,150 tax credit). What they do qualify for varies by model. The Environmental Protection Agency (EPA) has a list of models that qualify and the amount each qualifies for [source: EPA]. If you bought a hybrid and put it into service before Jan.1, 2005, you can still qualify for a $2,000 tax deduction [source: EPA].

To learn more about AFVs, hybrid cars and different types of taxes, look over the links on the next page.

Related HowStuffWorks Articles

More Great Links

Sources

  • Environmental Protection Agency Fuel Efficient Vehicle Tax Incentives Information Center. http://www.fueleconomy.gov/feg/taxcenter.shtml­
  • Epstein, Lita "Green Tax Guide: Buy a Hybrid Car or AFV and Save on Taxes." Green Daily.com, January 24, 2008.
  • Internal Revenue Service. Hybrid Cars and Alternative Fuel Vehicles. http://www.irs.gov/newsroom/article/0,,id=157632,00.html
  • U.S. Department of Energy. "Energy Policy Act of 2005: What the Energy Bill Means for You." http://www.doe.gov/taxbreaks.htm