How the Hybrid Tax Credit Works

Qualifying for the Hybrid Tax Credit
If you buy a new hybrid car between Jan. 1, 2006 and Dec. 31, 2010, you might be able to get a decent tax credit.
If you buy a new hybrid car between Jan. 1, 2006 and Dec. 31, 2010, you might be able to get a decent tax credit.
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First of all, we should note the difference between a credit and a deduction, because one will leave you paying a little more. It turns out a credit is slightly more helpful than a deduction. A tax credit reduces the amount of money you owe the IRS right away. For example, if you earn $40,000 per year and are taxed at 10 percent, you'll owe the IRS $4,000. A tax credit of $500 will reduce the amount you owe to $3,500. A tax deduction is subtracted from your income before taxes, however. So a deduction of $500 reduces your taxable earnings to $39,500, and 10 percent of $39,500 will leave you owing $3,950.

So, right off the bat, changing the policy to a tax credit looks better for owners of these fuel-efficient vehicles. And it's possible to get a federal income tax credit of up to $3,400, a significant amount of money for most taxpayers. But there are some important rules to be aware of when purchasing a new hybrid with the tax credit in mind.

First of all, you can only use the credit for new hybrid cars placed in service on or after January 1, 2006. If the vehicle was bought prior to January 1, 2006, sorry -- you're out of luck. The owner also needs to buy the hybrid before December 31, 2010, which is when the Energy Policy Act of 2005 will end. This is because lawmakers in Congress have set aside a certain period of time for the tax credits to work their magic; when the time comes, they'll look at the effect the tax incentives had during that time period and revise their policies accordingly.

Another qualification for the hybrid tax credit involves the car owners and where they primarily use the car. Qualified hybrid car owners have to do most of their eco-friendly driving in the United States. Also, the credit is only available to the original owner -- it won't work if the car is resold. It's also important to note that leasing a hybrid won't necessarily get you a credit, since the leasing company actually has the right to claim the credit.

The IRS keeps a list of the qualified cars and related credit amounts on its Web site, so if you're wondering if a certain hybrid you bought within the correct time period qualifies for a tax credit, you can go to the IRS Web site to find out. The organization also adjusts the credit amount according to a schedule. What schedule, you ask? Read the next page to find out.