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The Energy Tax Incentives Act of 2005

The Energy Tax Incentives Act of 2005

The recent act signed into law by President Bush was promoted by the popular press as a lucrative gift to energy companies. However, it contains a few nice tax breaks for consumers including credits for home improvements and car purchases.

A subtle but important point is that these tax breaks are credits – the best kind of tax break since they reduce tax liability dollar for dollar.

As you might imagine, the rules and calculations can be a bit cryptic.

It’s tax law after all! In any case, here’s a summary of what’s in store…

The lifetime limit is $500. It is calculated by taking 10% of expenditures for qualified energy efficiency improvements and adding them to 100% of expenditures on qualified residential energy property. The energy-savings items must be put into use between 1/1/06 and 12/31/07.

Examples of “10% property” are metal roofs coated with heatreduction pigments, insulation materials designed to reduce heat gain or loss, exterior windows including skylights (the credit is limited to $200 for windows) and exterior doors.

Examples of “100% property” are electric or geothermal heat pumps and central air conditioners (credit limited to $300 for this category), natural gas, propane or oil furnaces (credit limited to $150 for this category) and advanced main circulating fans (credit limited to $50).

This separate credit is equal to 30% of the cost of things such as solar water-heating equipment (maximum credit of $2,000) and fuel-cell property (maximum credit of $500 for each 0.5 kilowatt of capacity).

Again, items must be put into use between 1/1/06 and 12/31/07. The credit is disallowed if the water-heating equipment is used for a swimming pool.

Before we get to the new credits, there’s a change applicable to 2005 worth mentioning. Consumers are allowed a $2,000 deduction (not credit) for purchasing (not leasing) a qualifying new (not used) clean fuel vehicle. This deduction disappears after 2005 and is replaced by the following four credits for vehicles put into use on or after 1/1/06:

Hybrids with a gross vehicle weight less than or equal to 8,500 pounds qualify for a two-part credit. The “fuel economy credit” – based on fuel-efficiency improvements versus the 2002 model year – can range between $400 and $2,400. The “conservation credit” – based on expected fuel consumption reductions over the vehicle’s life – can range between $250 and $1,000.

A little simple math tells us the maximum credit available if $3,400 – wow! This isn’t a bad deal and goes a long way in making up for the price premium of buying a hybrid.

“Lean burn” vehicles – those that use the traditional internal combustion engine but combine it with a higher-than-normal amount of air – are eligible for the same credits as hybrids (see #1 above).

Think diesel when you hear “lean burn”.

“Fuel cell” vehicles – those that run on hydrogen cells for example – also get a two-part credit. Part one is based on vehicle weight and part two is based on fuel-efficiency improvements over 2002 model year vehicles. Although the maximum combined credit is high ($12,000), finding a fuel cell vehicle is extremely difficult.

“Alternative fuel” vehicles run LNG (liquefied natural gas) or some other type of fuel that is at least 85% methanol. The maximum credit here is $4,000 but, like “fuel cell” vehicles, this type of vehicle is difficult to find.

First, these credits are worthless if you get hit with the AMT – something more and more of us are dealing with under the antiquated AMT rules. Second, auto credits #1 and #2 have phase-outs tied to the number of vehicles sold per manufacturer. The idea being that foreign carmakers will benefit early-on (think Toyota and Honda) so that, down the road, American manufacturers will have full credits remaining which might provide incentives for purchases of their vehicles.

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