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Harnessing hybrid-car tax credits

How much of a tax break you get varies according to which type of hybrid vehicle you buy, with the maximum being $3,150 for a Toyota Prius, shown here.AP
/ Source: BusinessWeek Online

Back in March, Bonnie Monahan, vice-president of planning and business development at Timberland, decided to hurry up and trade in her 2000 Volkswagen Passat for a nifty new Toyota Highlander hybrid.

Monahan wanted to save money on gas and do her part to clean up the environment, but she decided to buy now rather than next year for financial reasons. The environmentally conscious Stratham, N.H. shoe company she works for gives employees $3,000 for buying a hybrid. Also, she knew if she hurried she could get the full $2,200 federal tax credit on a Highlander hybrid before the tax breaks start phasing out this fall. All that made buying a Highlander now "a really hard thing to turn down," she says.

With some more tepid-selling hybrids, dealers are even offering discounts this year. When Monahan bought her Highlander in March, two Toyota dealers ended up competing for her business. On top of the $3,000 Timberland gave her and a $2,200 federal tax credit, the winning dealer took $3,719 off the hybrid's $40,719 list price — lowering her net cost to just $31,800. Now, her husband is talking about replacing his minivan with a hybrid.

Monahan's experience illustrates a key point about the market for hybrids: How much you pay can depend on when you buy, where you live, and even where you work. And while it may take years for hybrids to pay off financially for many buyers, there are now numerous federal, state, and local incentives that can dramatically change the equation.

Time limits
On top of the federal tax break of as much as $3,150, for instance, the state of Colorado offers an additional tax break of $4,181 to $4,713 on a Honda Insight, $3,434 on a Toyota Prius, $2,156 to $2306 on a Honda Civic, and $2,758 to $2,797 on a Ford Escape or Mercury Mariner hybrid. West Virginia and New York, among other states, also have generous tax credits for hybrids. And Google and Hyperion Solutions, the Santa Clara, Calif.-based software company, offer employees $5,000 toward the purchase of a high-mileage hybrid like the Prius or Civic.

The first thing to keep in mind if you want a hybrid — especially a Toyota — is that it may pay to place your order sooner rather than later. That's because federal government tax credits for buying a hybrid are scheduled to start gradually phasing out soon. Under the complicated federal rules for the phase-out, which are based on the volume of hybrids each company sells, the tax breaks on Toyota's hybrids are scheduled to diminish first — starting in October, when they'll be cut in half.

Next April, the incentives on Toyota hybrids will drop to one-quarter of the current level, and in October, 2007, they'll drop to zero. That's because the phase-out starts after a manufacturer has sold 60,000 hybrids (beginning Jan. 1 of this year) and Toyota, which controls about 70% of the U.S. hybrid market, had already sold more than 60,000 hybrids by the end of May.

Price breakdown
Other manufacturers, such as Honda, Ford, General Motors, and Nissan, sell far fewer hybrids, so the phase-out of the federal tax credit probably won't start on their models until next year or later. On June 7, Honda announced that customers who buy its 2006 hybrid models may be eligible for a tax credit of up to $2,100.

Of course, Congress could always extend the tax breaks for hybrids, a move supported by President Bush and environmental groups. But that's far from certain. And in the meantime, the federal tax credit can make hybrids a lot more affordable. How much you get varies according to which type of vehicle you buy, with the maximum being a tax break of $3,150 for a Prius.