The 2010 Cumulative Tax Guide

GENERAL TAX MATTERS - NEW LEGISLATION

I. SUPPLEMENTAL APPROPRIATIONS ACT

President Signs Supplemental Appropriations Act Which Includes Tax-Free "Cash for Clunkers" Provision

On June 18, the Senate passed H.R. 2346, the Supplemental Appropriations Act of 2009. The House had previously passed the measure, and on June 24, the President added his signature. Title XIII of the Act dubbed the "Consumer Assistance to Recycle and Save Act" (i.e., the "cash for clunkers" provision) provides a cash incentive for both individuals and businesses to trade in older gas-guzzling vehicles for new, more fuel-efficient ones. The incentive takes the form of a voucher of $3,500 or $4,500 depending on the type of vehicle traded in and the fuel efficiency of the vehicle purchased. But, the new vehicle would have to be purchased between July 1 and November 1 of 2009. Nevertheless, neither the $3,500 or $4,500 vouchers will be treated as gross income for income tax purposes, or for federal or state assistance programs.

Comment: Although it was slated to run out of money (i.e., $1 billion had been budgeted for the program) after just the first week that it was effective, the House on 7/31/09 voted to shift an additional $2 billion to keep it going.

Comment: Dealers would be required to scrap the traded-in vehicles, so the program probably would not attract higher value trade-ins. And, to qualify, the trade-ins must be 1984 or later models that are in drivable condition and must have been titled and insured in the taxpayer's name for at least one year before the trade-in date.

Background: Here is a summary of the new provision:

Passenger Autos: The voucher amount is $3,500 if the new fuel efficient automobile is a passenger automobile and its combined fuel economy (CFE) is at least 4 mpg higher than the CFE of the eligible trade-in vehicle. The voucher amount increases to $4,500 if the new fuel efficient vehicle's CFE is at least 10 mpg higher than the CFE of the eligible trade-in vehicle.

Trucks ($3,500 voucher): The voucher amount is $3,500 if: (1) the new fuel efficient vehicle is a "category 1 truck" and its CFE is at least 2 mpg higher than the CFE of the eligible trade-in vehicle; (2) the new fuel efficient vehicle is a "category 2 truck" that has a CFE of at least 15 mpg and: (a) the eligible trade-in vehicle is a category 2 truck and the CFE of the new truck is at least 1 mpg higher than the CFE of the eligible trade-in vehicle; or (b) the eligible trade-in vehicle is a "category 3 truck" of model year 2001 or earlier; or (3) the new fuel efficient vehicle is a "category 3 truck" and the eligible trade-in vehicle is a category 3 truck of model year of 2001 or earlier and is of similar size or larger than the new fuel efficient vehicle vehicle as determined in a manner prescribed by the Treasury Secretary.

Trucks ($4,500 voucher): The voucher amount is $4,500 if: (1) the new fuel efficient vehicle is a "category 1 truck" and its CFE is at least 5 mpg higher than the CFE of the eligible trade-in vehicle; (2) the new fuel efficient vehicle is a "category 2 truck" that has a CFE of at least 15 mpg and its CFE is at least 2 mpg higher than the CFE of the eligible trade-in vehicle and the eligible trade-in vehicle is a "category 2 truck."

Key Definitions: A "passenger auto" is one meeting the definition at USC title 49, §32901(a)(18) that has a CFE of at least 22 mpg. A "category 1 truck" is a non-passenger auto as defined at USC title 49, §32901(a)(17), that has a CFE of at least 18 mpg, a "category 2 truck" is a large van or large pickup as categorized by the Treasury Secretary; and a "category 3 truck" is one defined as such at USC title 49, §32901(a)(19). The term "CFE" depends on the model year, whereas, a "new fuel efficient auto" is a passenger auto, or category 1, 2, or 3 truck as defined above and which meets the following requirements: (1) the equitable or legal title of which has not been transferred to any person other than the ultimate purchaser; (2) that carries a manufacturer's suggested retail price of $45,000 or less; (3) that meets certain certification standards, and (4) that has the CFE of at least: (a) 22 mpg for a passenger auto; (b) 18 mpg for a category 1 truck; or (c) 15 mpg for a category 2 truck.

Comment: The qualifying replacement vehicle must be new, but a "demonstrator" vehicle which has never been titled may qualify even if it had substantial mileage.

Trade-In Vehicles: Trade-in vehicles eligible for the voucher program are those that at trade-in time: (1) are in "drivable condition;" (2) have been continuously insured and registered to the same owner for at least one year; (3) were manufactured less than 25 years before the trade-in date; and (4) in the case of an auto, achieve a CFE of 18 mpg or less.

Comment: A single person may get only one trade-in voucher and only one voucher is available for joint registered owners of a single eligible trade-in vehicle. Comment: The one-year rule prevents someone from buying an old clunker now and making money on a trade-in.

Comment: For passenger autos, the mpg limits mean that the old car could not have had a CFE of more than 18 mpg, and the new one must have at least a CFE of 22 mpg, as well as exceeding the old one's CFE by at least (a) 4 mpg (for a $3,500 voucher) or (2) 10 mpg (for a $4,500 voucher).

Tax Treatment of Voucher: The voucher, which will be sent by the Treasury to the dealer, will offset the new vehicle's purchase price or lease price for a "qualifying lease." A qualifying lease is a lease of an auto for at least five years. The selling dealer must use the voucher in addition to any other rebate or discount that it advertises or the manufacturer offers, and the voucher is not permitted to offset a rebate or discount. There are other restrictions on the dealer, such as having to scrap the traded-in vehicle, except for certain salvaged parts.

Overall Program Limits: A total of $1 billion is allocated to the trade-in initiative (but, according to administration officials, less $50 million for administration of the program), and no more than 7.5% of the total program funds can be used for buying or leasing "category 3 trucks." Within 30 days of the enactment date (i.e., June 24), Treasury is to provide details and requirements relating to the program, including a comprehensive list, by make and model, of new fuel efficient autos meeting the requirements of the voucher program.

Income Tax Treatment: The voucher amounts will not have to be included in the recipient's gross income. Furthermore, because the vouchers are tax-free, it will have the following effects on the purchase of the new vehicle:

If the purchaser is an individual whose basis (i.e., cost for tax purposes on a personal use car) on the old vehicle exceeds the voucher's value, and viewing the voucher as a trade-in allowance, the income-tax-free feature yields no advantage (i.e., since a loss on a personal auto is not deductible). But, on the other hand, if the taxpayer bought the old car for less than the voucher's value, the economic gain will also not affect gross income.

Since the voucher is excluded from gross income, a business that utilizes the program is treated as if it traded in the old vehicle and received nothing for it. As a result, its basis in the new vehicle would be the amount it pays, net of the voucher and any other rebates. If the purchaser is a business that has depreciated the old vehicle down to zero (or, it has a very low basis), trading it in under normal circumstances would generally not result in any Sec. 1245 recapture (Code §245(b)(4)) and the basis of the new vehicle would equal its cost. (Code §245; Gas Guzzler Voucher)

Comment: For a business, trading in a qualifying vehicle (i.e., an old gas guzzler) with a low or zero basis is definitely better than selling it for an amount equal to or less than the voucher's value. In fact, it may even pay to forego a higher sale price and instead trading in the old vehicle and getting a tax-free voucher. For example, if a business with a marginal tax bracket of 30% sells a zero-basis truck for $6,000, it would have $4,200 left after paying a $1,800 tax (i.e., due to Sec. 1245 depreciation recapture). But, if the business instead trades in the old truck and qualifies for a tax-free $4,500 voucher under the new program, it would be $300 ahead.

Comment: Buyers may also still be able to claim an income tax deduction for qualified motor vehicle taxes paid on the vehicle, whether they itemize or claim the standard deduction. Additionally, buyers may be able to claim a credit for vehicles that qualify for the hybrid credit for vehicles qualifying under Code §30B, or the advanced lean burn technology motor vehicle credit under Code §30B(c). The credits varies with the type of vehicle.

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