If you are thinking about making your home more energy efficient or purchasing a hybrid car, you may be eligible for some income tax breaks.  However, as discussed below, currently these tax breaks may not help taxpayers subject to the Alternative Minimum Tax (AMT).

In August of 2005, Congress passed and President Bush signed the Energy Tax Incentives Act of 2005.  This massive piece of legislation took over four years of negotiations and went through numerous revisions before becoming law.  Much of the $14.5 billion in tax breaks are for the benefit of oil and natural gas companies and electric utilities, but there are tax credits and provisions that will have an impact for small businesses and individual home owners.  In this article, we will address briefly only the provisions pertaining to home improvements and hybrid car purchases.

The consumer tax breaks in this Act are in the form of tax credits.  Credits are dollar-for-dollar reductions of your federal income tax and, therefore, are worth more than a deduction.  These tax credits are not enough by themselves to justify any home improvement projects, but if you are already planning some upgrades, these “gifts” from the IRS may help you shave money from your tax bill.

I.      EFFICIENT HOMES

This tax credit is up to 10% of the cost of energy-saving home improvements for a “lifetime” maximum of $500.  The credit is limited to improvements completed after December 31, 2005 and before January 1, 2008.  Though the amount you can claim for specific improvements is capped, a combination of improvements can be made to reach the $500 limit.  Qualifying improvements and the applicable tax benefit include:

1.      Exterior windows, including skylights and storm windows with a credit of 10% of the total cost up to $200.

2.      Insulation, exterior doors or pigmented metal roofs, including seals to limit air infiltration (such as caulk, weather stripping, and foam sealants) as well as storm doors with a credit of 10% of the cost of the product (but not the installation) up to $500.

3.      Central air conditioner, heat pump, or water heater with a credit of up to $300 towards the full purchase price, including installation costs.

4.      Furnace or boiler with a credit of up to $150 towards the full purchase price, and/or $50 for an efficient air-circulating fan in a furnace, including installation costs.

To qualify for these tax credits, it will take some “energy” on your part since there are specific guidelines as to what is eligible for the credits.  So, before you purchase a new hot water heater, for instance, make sure it is on the eligible list.  Qualifying equipment and items generally must satisfy IRS-approved energy-efficiency standards.  Windows, doors and insulation must meet specified requirements, however, all ENERGY STAR windows qualify.  Metal roofs must have pigmented coatings that meet ENERGY STAR requirements.  Heating and cooling equipment must meet stringent efficiency requirements and not even all ENERGY STAR products will qualify.  In addition, windows, doors, insulation and roofs must be expected to last at least five years.  Manufacturers can certify in packaging or on the company’s website which of the products qualify for the tax credit.  Retailers, contractors and manufacturers should be able to assist you in determining what levels of insulation and what other products qualify.

All the improvements must be installed in or on a taxpayer’s principal residence in the United States.  In order to obtain these tax credits, you will need to file the appropriate IRS form with your tax returns.  In addition, you will need to keep receipts proving that you purchased the improvements and a copy of the manufacturer’s certification (or the ENERGY STAR label for windows).  Accountants and tax advisors should also be able to provide more guidance.

 The maximum tax credit for any combination of the items above is $500.

Solar energy devices are in a different category and the potential tax credit is significantly higher and can be taken in addition to the 10% or $500 credit mentioned above.  Homeowners who install:

1.      A solar water heater used in a principal or secondary residence that meets certain certification requirements may be eligible for a credit not to exceed $2,000 for a taxable year; and/or 

2.      Modular solar panels, commonly known as photovoltaics, PV panels or PVs, that provide either a supplemental or exclusive source of electricity to your principal or secondary residence are also eligible for a credit worth 30% of the cost, up to $2,000 for a taxable year. 

3.      Taxpayers are also allowed a 30% tax credit for the purchase of qualified fuel cell power plants.  The credit may not exceed $500 for each 0.5 kilowatts of capacity.

II. HYBRID CARS

In addition to tax credits designed to prod us to use less energy at home, there are tax credits for purchasing certain fuel-efficient vehicles, known as hybrids.  A hybrid car combines an internal combustion engine with another propulsion system that uses an on-board rechargeable energy source, such as electric batteries.  Beginning January 1, 2006, hybrid-car buyers may be eligible for tax credits ranging from $250 to $3,400 depending on the fuel economy and the weight of the vehicle.  Hybrid vehicles that use less gasoline than the average vehicle of similar weight and that meet an emissions standard qualify for the credit.  “Lean-burn” diesel vehicles could also qualify, but currently available diesel vehicles do not meet the emission standard.  There is a similar credit for alternative fuel vehicles and for fuel cell vehicles.  If individuals and businesses buy more than one vehicle, they are eligible to receive a tax credit for each.  If a tax-exempt organization buys a hybrid vehicle, the retailer is also eligible to receive another credit.

The tax credit for hybrid vehicles is available for vehicles placed in service, beginning January 1, 2006, but there is a potential penalty for waiting too long to buy.  Each automaker can sell only 60,000 vehicles that qualify for the credit, so credits on popular models could disappear long before the tax break expires at the end of 2009.

Unless Congress changes the AMT, it is likely that many upper-middle-income home owners and car buyers may be prevented from receiving these tax breaks.  A provision in the Tax Code which had the effect of exempting this type of energy savings credit expired at the end of 2005.  The AMT was introduced in 1969 as a parallel tax system originally designed to insure the very wealthy did not deduct their way out of paying their share.  Too many deductions or credits trigger the AMT for unsuspecting taxpayers.  Since the AMT is not indexed for inflation, each year more taxpayers become ensnared in the AMT web as our cost of living increases.  Unless Congress acts soon, the AMT threatens to affect 20 million taxpayers this year and 30 million by 2010.  A tax-reform panel has recommended eliminating the AMT, but repeal would cost the U.S. Treasury $1.2 trillion over the next decade.  So, hope for some AMT relief to be passed by Congress before the filing deadline for your 2006 return.

To take advantage of the tax breaks and achieve long-term energy savings, you should start prioritizing your home improvement energy projects and hybrid car purchases now.  Once a list with related costs is made, consulting a tax advisor is essential to help sort through all the new rules and to structure your purchases for maximum tax benefit.