Background: If you purchase a qualified vehicle after February 16, 2009, and before January 1, 2010, you may deduct the sales and excise taxes attributable to the first $49,500 of the vehicle’s price. For this purpose, “qualified vehicles” include passenger cars, light trucks, motorcycles and sport utility vehicles (SUVs) weighing no more than 8,500 gross pounds. Motor homes are also eligible for this deduction.
This tax break can only be claimed by the initial purchaser of the vehicle. In addition, it is not available for used vehicles, only new ones. It is not official if the deduction can be claimed for multiple vehicle purchases, but it is logical that the deduction would be allowed for any purchase up to $49,500. The IRS is expected to issue guidance soon.
Note that the new deduction is especially valuable because it is claimed “above the line” on your return (i.e., it is used to arrive at AGI). Therefore, it can result in other tax return benefits.
However, there is a major drawback to the deal: The deduction is phased out if your modified AGI (MAGI) exceeds a specified threshold. The phaseout begins at $125,000 of MAGI for single filers and $250,000 for joint filers. Once your MAGI exceeds $135,000 or $260,000 of MAGI, respectively, you cannot claim any deduction.
Furthermore, the new deduction must be coordinated with the existing optional deduction for sales tax. Essentially, you can claim one of these tax breaks, but not the other.
How it works: Under current law, you may choose to deduct state and local sales taxes instead of deducting state income tax. The sales tax deduction may be based on actual expenditures (if you have kept proper records) or a state-by-state table provided by the IRS. The sales tax on certain “big-ticket items” like cars may be added to the table amount. If you elect this option, you cannot also deduct the same sales tax attributable to a qualified new-vehicle purchase.
Should you opt for the new-vehicle deduction or the sales tax deduction? It depends on your particular circumstances. Residents of states with high income tax rates may bypass the optional sales tax deduction anyway. On the other hand, if you would not benefit from the new-vehicle deduction under the phase-out rule, you might elect the optional sales tax deduction.
Finally, you should also be aware that the new-vehicle deduction is allowed in the computation of the alternative minimum tax, but the optional sales tax deduction is not. This could have an impact on your tax situation.
Best approach: Seek professional guidance. The potential tax benefits should be considered as part of your car-buying decision.
Other articles in the January 2010 Edition of Business Matters: