How the 2009 New Car Tax Credit Works

The new car tax credit was included on the 2009 stimulus package, and it’s causing a lot of confusion for a lot of people. I’ve studied the brief IRS explanation and several other sources to figure out how the credit works.

New Car Credit Eligibility Dates

The credit applies to new cars purchased between February 17, 2009 and December 31, 2009. That means the purchase must be completed, not that you’re working on a deal on December 31. If you completed the deal on February 16, you’re out of luck.

Qualifying Vehicles

New cars, light trucks, motor homes, and motorcycles qualify. Used or pre-owned cars do not, even if it’s “new to you.”

Qualifying Purchase Price

Here’s the tricky part. The credit is limited to the taxes on vehicles with a purchase price up to $49,500. You can buy a more expensive car than that, but you can only deduct the taxes on $49,500 of it. That’s still a pretty penny if you live in a high sales tax state.

Qualifying Income

The income limit is high enough that nearly everyone will qualify. The credit starts to phase out at $125,000 for individuals and $250,000 for couples. Once you reach $135,000 and $260,000, respectively, you no longer qualify.

Eligible Taxes

Although there was initial talk of including loan interest, the credit is limited to the sales, local, and excise taxes associated with the purchase. The IRS estimates that will be about $1500 on a $25000 car, but it does depend on the prevailing tax rate in your state and city. See the first comment for a better explanation of the actual value of the credit.

As of June, 2009, the IRS has clarified that fees collected by states that don’t collect sales taxes will qualify for the credit.  These states include Alaska, Delaware, Hawaii, Montana, New Hampshire and Oregon. Please consult the IRS to find out precisely which fees are eligible in those states.

How to Claim the New Car Tax Credit

You don’t receive the credit when you buy the car, so you should still bargain for the best deal you can get. You’ll receive the credit when you file your 2009 taxes, which are due on April 15, 2010. The credit is considered an “above the line” credit, so you don’t need to itemize to receive it. It also reduces your taxable income, rather than the tax due. That means your total savings will be more than less than the credit itself. If you itemize your taxes, include the sales tax on schedule A. If you don’t, complete 1040 Schedule L to determine your deduction. Note: there are two Schedule L’s. You want the one associated with form 1040 (linked above), not the one associated with form 990.

The Bottom Line

Here’s the bottom line: the credit may or may not be worthwhile to you. If you were considering a late model used car, then you need to compare the difference in price of the used car and the new car, as well as the taxes on the new car. If the used car is significantly cheaper than the new car, the credit may not actually save you money. However, if the difference in price is about the same as the tax on a new car, then the credit could ultimately make the new car a better deal. With the new car, you’d not only receive the credit, but you’d avoid major maintenance and repair costs for longer. However, you do need to factor in higher loan payments, registration fees, and insurance costs.

My best advice is to shop for a car as you normally would, and then see if the credit is a deciding factor after all other factors are considered.

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