New Motor Vehicle Tax Deduction

A Little Tax Planning Can Save You Money

If you planning to purchase a new car this year, please continuing reading as you just might save a few tax dollars.

One tax provision of The American Recovery and Reinvestment Act of 2009 is designed to generate more automobile purchases with a new income tax deduction for state or local sales or excise taxes paid on qualifying 2009 motor vehicle purchases.

New temporary deduction

For purchases on or after Feb. 17, 2009 and before Jan. 1, 2010, the Recovery Act expands the definition of taxes allowed as a deduction to include qualified motor vehicle taxes paid or accrued within the tax year.

The deduction generally is allowed to itemizers, and to those claiming the standard deduction as an addition to that deduction.

Qualified motor vehicle taxes are State or local sales or excise taxes imposed on the purchase of a qualified motor vehicle.

A qualified motor vehicle is a (1) passenger automobile, light truck or motorcycle the gross vehicle weight rating of which is not more than 8,500 pounds and (2) a motor home. The original use of the motor vehicle must begin with the taxpayer.

Only taxes on that part of the qualified motor vehicle's purchase price not exceeding $49,500 may be deducted.

Can the deduction be claimed for more than one vehicle?

The Code and legislative history are not clear on this. The deduction is allowed for "qualified motor vehicle taxes." This term means "any State or local sales or excise tax imposed on the purchase of a qualified motor vehicle." One could argue that the use of "a" as opposed to "any" or "one or more" suggests that the deduction is allowed only with respect to one vehicle.

The dollar limitation seems to confirm this in that it too uses "a" in its language. Specifically, it says that "[he amount of any State or local sales or excise tax imposed on the purchase of a qualified motor vehicle... shall not exceed the portion of such tax attributable to so much of the purchase price as does not exceed $49,500."

On the other hand, one could argue that "a" being an indefinite article shouldn't be interpreted as "one." But if the deduction were available for two (or more vehicles), the $49,500 limitation would produce an anomalous result - an individual buying two cars each costing $49,500 could deduct the taxes on both whereas another individual buying one car costing $99,000 could only deduct the tax on the first $49,500. Thus, the better view seems to be that the deduction is limited to the tax on one qualified motor vehicle subject to the applicable limitations. But IRS guidance will have to resolve the matter.

What about an individual who buys two cars costing not more than $49,500 in the aggregate?

From a policy standpoint, there would be no rea­son to deny the deduction to such an individual given that he could deduct the taxes on a single vehicle costing not more than $49,500 (or on the first $49,500 of the purchase price of a higher costing vehicle). However, again it boils down to whether the Code permits a deduction for more than one vehicle. If so, then the limitation would be $49,500 on each vehicle and there would be no issue of splitting the limitation among two or more vehicles.

... In the case of married taxpayers, can each spouse deduct the tax on up to $49,500 of the pur­chase price of his or her own vehicle, whether they file jointly or separately? Here, too, guidance is needed from IRS.

Income limitation. The amount of sales or excise taxes that may be treated as qualified motor vehicle taxes is phased out ratably for a taxpayer with modi­fied AGI (MAGI) between $125,000 and $135,000 ($250,000 and $260,000 on a joint return). MAGI is adjusted gross income for the tax year increased by any amount excluded from gross income under Code Sec. 911 (foreign earned income and foreign housing exclusions), Code Sec. 931 (exclusion of income derived from American Samoa) or Code Sec. 933 (exclusion of income from Puerto Rico).

Illustration (1): Taxpayer purchases a car for $25,000 in a locality that imposes a 6% sales tax. Taxpayer's modified AGI is $130,000. The quali­fied motor vehicle tax is $1,500. The purchase price limitation does not apply. However, since Taxpayer's modified AGI exceeds $125,000 by $5,000, the taxpayer's qualified motor vehicle tax deduction is reduced by $750 ($1,500 X $5,000/$10,000). Thus, Taxpayer may claim a $750 qualified motor vehicle tax deduction.

Illustration (2): Taxpayer purchases a car for $25,000 in a locality that imposes a 6% sales tax. The taxpayer's modified AGI is $135,000. The qualified motor vehicle tax is $1,500. The purchase price limitation does not apply. However, since the taxpayer's modified AGI exceeds $125,000 by $10,000 the taxpayer's qualified motor vehicle tax deduction is reduced by $1,500 ($1,500 x $10,000/$10,000). Thus, no deduction is permitted in this case.

Interplay with pre-2010 optional sales tax deduc­tion for itemizers.

The deduction for qualified motor vehicle taxes is not available to a taxpayer who elects to deduct state and local sales and use taxes in lieu of income taxes as an itemized deduction.

Observation: This means that, for those who itemize and choose to deduct state sales taxes in lieu of state income taxes, the new deduction is not allowed. That's because, such individuals can already deduct the sales tax on a car purchase. The prohibition prevents a double deduction for the same item.

Caution: In comparing the optional sales tax and the new deduction, there are a few caveats. For purposes of the optional sales tax deduction, (1) if the rate of tax on motor vehicles exceeds the general sales tax rate, the deduction is limited to the general rate; and (2) there is no purchase price limitation or separate income limitation.

Observation: The rule could limit the deduction where the sales tax rate on an auto purchase is higher than the general sales tax rate, especially where the car is modestly priced. If the car's cost is well in excess of $49,500, that difference would probably become immaterial and it would be better to take the unlimited general sales tax deduction than the Recovery Act's new deduction for those who have a choice.

Observation: In states where there is an income tax, the election will usually only be made if there is a purchase of some major item such as an auto. Thus, in such states the elec­tion will be less likely to be made now since the deduction for qualified motor vehicle taxes can be made even if income taxes are deductible. For example, if state and local sales taxes are equal to $5,000 including $2,500 on the purchase of a qual­ified motor vehicle, and state income taxes are $4,000, under pre-Recovery Act law, a taxpayer would elect to deduct sales taxes instead of income taxes so as to get a $1,000 additional deduction ($5,000 instead of $4,000). However, under the Recovery Act, a taxpayer would get a total deduc­tion of $6,500 if he doesn't make the election, i.e., $4,000 of income taxes and $2,500 for taxes on the qualified motor vehicle. This assumes there's no MAGI-based phaseout of the deduction.

Interplay with AMT. The deduction for qualified motor vehicle taxes is allowed in computing the AMT. This is to be contrasted with the optional itemized deduction for state and local sales and use taxes, which is not allowed in computing the taxpayer's AMTI.

Observation: If a taxpayer would be subject to the AMT before taking any deduction for state or local taxes into account, the taxpayer would never benefit by electing to deduct state or local sales or use taxes instead of income taxes since such a deduc­tion would not be allowed in computing the AMT, and the taxpayer would lose the deduction for sales or excise taxes paid on a qualified motor vehicle. While making the election would reduce his regular tax, the AMT would be increased by the same amount that the regular tax was reduced.

In the following examples we assume, solely for purposes of simplification, that allowing the deduction for sales or use taxes on a qualified motor vehicle in computing AMT will not affect the amount of the exemption allowed in determining the taxable excess (alternative minimum taxable income (AMTI) less exemption amount) on which the tentative minimum tax is computed.

Illustration (3): A married couple who file a joint return live in a state that has no state or local income tax. They itemize their deductions and are in a 28% tax bracket for regular income tax pur­poses and a 26% tax bracket for AMT purposes. In 2009, they pay state sales taxes of $5,000 including taxes of $2,500 on the purchase of a qualified motor vehicle.

Before taking into account any deduction for the payment of those taxes, their ten­tative minimum tax is $26,000 (26% of taxable excess of $100,000) and their regular income tax is $25,500. Accordingly they owe an AMT of $500 ($26,000 less $25,500). The total tax payable will be $26,000 (i.e., regular income tax of $25,500 plus AMT of $500). In effect the total tax is the tentative minimum tax.

If they elect to deduct their sales taxes, their taxable income will be reduced by $5,000 and their regular income tax will be reduced by $1,400 (28% of $5,000) to $24,100. However, their taxable excess will remain at $100,000 since sales taxes are not deductible in computing alternative minimum taxable income.

Accordingly, the tentative minimum tax will remain at $26,000, and the AMT will increase to $1,900 ($26,000 less $24,100). The total taxes payable will remain at $26,000 (i.e., regular income tax of $24,100 plus AMT of $1,900).

On the other hand, if the taxpayers don't make the election to deduct sales taxes, they will be able to deduct the $2,500 they paid for a qualified motor vehicle against both regular income tax and the ten­tative minimum tax. Thus, their regular income tax will be reduced by $700 (28% of $2,500) to $24,800), and their tentative minimum tax will be reduced by $650 (26% of $2,500) to $25,350. While their AMT will increase by $50 to $550, the total taxes payable will be reduced by $650 from $26,000 to $25,350 (i.e., regular income tax of $24,800 plus AMT of $550).

Observation: If a taxpayer would not be subject to the AMT before taking any deduction for state or local income taxes or state or local sales and use taxes into account, then whether the taxpayer would be better off electing to deduct sales and use taxes instead of taking the deduction for sales or excise taxes paid on a qualified motor vehicle would depend mainly on by how much the regular income tax exceeds the tentative minimum tax. The larger the excess, the more likely it is that the taxpayer will benefit by making the election to deduct sales and use taxes.

Illustration (4): Same facts as in illustration (3) except that the taxpayers' regular income tax is $27,000, i.e., $1,000 more than their tentative mini­mum tax of $26,000. If they don't make the election to deduct sales and use taxes, their regular income tax will be reduced by $700 (28% of $2,500 sales tax paid on purchase of qualified motor vehicle) to $26,300. This still will be $950 more than the tenta­tive minimum tax of $25,350 ($26,000 reduced by $650), so no AMT will be owed.

On the other hand, if they do make the election, their regular income tax will be reduced by $1,400 (28% of $5,000) to $25,600. Their tentative mini­mum tax will remain at $26,000 and they will owe an AMT of $400. Their total tax including the AMT will be $26,000 but this still will be $300 less than the $26,300 of regular income tax they will owe if they don't make the election to deduct sales and use taxes.

Illustration (5): Same facts as illustration (4) except that the taxpayers' regular income tax is $26,300, i.e., $300 more than their tentative mini­mum tax of $26,000. If they don't make the elec­tion to deduct sales and use taxes, their regular income tax will be reduced by $700 (28% of $2,500 sales tax paid on purchase of qualified motor vehicle) to $25,600. Their tentative mini­mum tax will be reduced by $650 (26% of $2,500) to $25,350 so no AMT will be owed. Their total tax will be the regular income tax of $25,600.

On the other hand, if they do make the election, their regular income tax will be reduced by $1,400 (28% of $5,000) to $24,900. Their tentative mini­mum tax will remain at $26,000 and they will owe an AMT of $1,100. Their total tax including the AMT will be $26,000, or $400 more than they would owe if they don't make the election to deduct sales and use taxes.