Energy Tax Credits

In late July, Congress passed the Energy Tax Incentives Act of 2005. The tax goodies have an advertised value of $14.5 billion, and there’s a very good chance some of them will favorably affect you, your business, or members of your family. The new tax breaks are intended to reward both domestic energy production and conservation. In general, the conservation measures (such as tax credits for qualifying fuel-efficient vehicles) will impact more taxpayers. In this letter we briefly summarize the changes we think are most likely to be important to you.

New Tax Credits for Vehicles

After this year, the 2005 Energy Act essentially repeals the tax deduction for new hybrid gas-electric passenger autos such as the Toyota Prius and Ford Escape. However, the law creates a new batch of so called alternative motor vehicle tax credits. These credits are available for new (not used) vehicles placed in service after 12/31/05. Credit amounts are determined under a complicated set of rules and are allowed for the following four types of vehicles.

• Hybrid Vehicles. Qualified new hybrid vehicles combine an internal combustion engine with another propulsion system that uses an onboard rechargeable energy source such as electric batteries. “Fuel economy credits” between $400 and $2,400 will be allowed for new hybrid autos and trucks with gross vehicle ratings of 8,500 pounds or less. The credit amount depends on how much improved the vehicle’s fuel economy is over comparable vehicles from the 2002 model year. In addition, “conservation credits” of $250 to $1,000 are allowed for hybrid vehicles based on anticipated lifetime fuel savings. The minimum combined credit amount for a hybrid vehicle that qualifies for both the fuel economy and conservation credits will be $650, while the maximum combined credit will be $3,400.
• Advanced Lean Burn Technology Vehicles. Qualified new lean burn vehicles are passenger autos and light trucks with an internal combustion engine that uses lean burn technology, which involves direct injection of a fuel mix with a bigger than normal helping of air (such as certain diesel engines). The credit amounts are the same as for hybrid vehicles with gross vehicle weight ratings of 8,500 pounds or less.
• Fuel Cell Vehicles. Qualified new fuel cell vehicles include, for example, those that run on hydrogen power cells. The fuel cell credit is composed of two parts: (1) a flat amount based on the vehicle’s weight and (2) an additional amount based on fuel efficiency. For a vehicle with a gross vehicle weight rating of 8,500 pounds or less, the maximum combined credit amount is $12,000.
• Alternative Fuel Vehicles. Qualified new alternative fuel vehicles include those capable of running solely on compressed or liquefied natural gas, liquefied petroleum gas, hydrogen, or any liquid that is at least 85% methanol. Reduced credits are allowed for vehicles that run on mixtures of alternative fuel and petroleum-based fuel. For vehicles with gross vehicle weight ratings of 8,500 pounds or less, the maximum credit can be up to 80% of the incremental cost of the alternative fuel technology. However, there is a $5,000 cap on the incremental cost, which translates into a maximum credit amount of $4,000.

You generally won’t be able to determine vehicle credit amounts on your own. For that, you will have to rely on information provided by the car manufacturers. Also, the credits for hybrid and lean burn vehicles will start getting phased out over a period of four calendar quarters once the manufacturer has sold over 60,000 qualifying vehicles. Finally, these vehicle credits cannot be used to reduce your federal income tax liability below the alternative minimum tax amount.

Personal Energy Property Credit

While the tax credits for motor vehicles are intriguing (after all, everybody loves a new car), the new personal tax credit for residential energy property expenditures will almost certainly benefit far more people. This new credit is limited to a lifetime amount of $500, and it only applies to items put to use after 12/31/05 and before 2008. The credit only applies to expenditures on your principal residence (no vacation homes). Qualified home improvements include the following:

• Metal roofs coated with heat-reduction pigments.
• Exterior windows, including those in skylights. (However, the lifetime credit amount for windows is limited to $200.)
• Exterior doors.
• Insulation materials or systems designed to reduce heat loss or gain.
• Energy efficient electric heat pumps, electric heat pump hot water heaters, geothermal heat pumps, and central air conditioners. The credit for expenditures on these items cannot exceed $300 per item.
• Qualified natural gas, propane, and oil furnaces and qualified hot water boilers. The credit for expenditures on these items cannot exceed $150 per item.
• Advanced main air circulating fans. The credit for expenditures on these cannot exceed $50 per item.
  

Personal Residential Energy Efficient Property Credit

A separate personal tax credit equals 30% of the cost of qualified solar water heating equipment (maximum credit of $2,000), 30% of the cost of qualified electricity generating solar photovoltaic property (also a maximum credit of $2,000), and 30% of the cost of qualified fuel cell property (maximum credit of $500 for each .5 kilowatt of capacity). This credit only applies to equipment put to use after 12/31/05 and before 2008 and is restricted to equipment for your personal residence. No credit is allowed for equipment used to heat swimming pools or hot tubs. The residence must be in the U.S., and the credit for fuel cell property is only available for your principal residence.

Credit for Manufacturers of Energy Efficient Appliances

Manufacturers are allowed a business tax credit for the manufacture of qualifying energy efficient dishwashers, clothes washers, and refrigerators in the U.S. The credit is available for appliances manufactured after 12/31/05 and before 2008. Despite what you may read elsewhere, this credit goes directly to the appliance manufacturers, and consumers will only benefit to the extent manufacturers pass along their tax savings to you.

Credit for Builders of Energy Efficient New Homes

Contractors that build new energy-efficient homes in the U.S. are eligible for a credit of $2,000 per housing unit. To qualify, the unit must have annual energy consumption for heating and cooling that is at least 50% less than comparable units. The credit can also apply to a substantial reconstruction and rehabilitation of an existing home. These credits only apply to homes sold by contractors for use as personal residences. Construction must be substantially completed after the 2005 Energy Act is signed into law by President Bush, and the home must be purchased after 12/31/05 and before 2008. This credit will benefit consumers to the extent contractors pass along their tax savings.

Deduction for Energy Efficient Commercial Building Improvements

An immediate deduction (as opposed to multi-year depreciation) is allowed for the cost of qualified energy-saving improvements to commercial buildings in the U.S. The maximum deduction is generally limited to $1.80 per square foot on a lifetime basis. The improvements must be installed as part of interior lighting systems; heating, cooling, and ventilation systems; hot water systems; or the building envelope. To qualify, the improvements must also meet a 50% reduced energy consumption standard. In some circumstances, a reduced deduction amount of $.60 per square foot may apply. The deduction is available for qualified energy efficient commercial building improvements put to use after 12/31/05 and before 2008.

Conclusions

One thing you may have noticed as you read through this was that there was no mention of any income-based phaseout rules designed to deny the new energy-related tax breaks to higher-earning individuals. In fact, there aren’t any such phaseout rules.

Finally, please understand that this letter only scratches the surface of all the new rules included in the fairly massive 2005 Energy Act. Please call us if you have questions or want more information.

Sincerely,

Gregory T. Stapp CPA/PFS, CFP

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