Cash for Clunkers Tax Rules

rat wagon
Creative Commons License photo credit: Kateweb

Around the blogosphere, I kept seeing stories pop up about some Cash For Clunker program and it got my curiosity.  While the closest thing to a clunker that I’ve drove was my 1992 Geo Storm (wow, do you remember those?), I don’t think that’s exactly what this program was intended for.  The program, which is part of the Consumer Assistance to Recycle and Save Act, was designed to give incentives to trade in old gas guzzling hogs for more fuel efficient ones.  Hmmm…..I wonder if I could have traded in that old Storm for a Prius?  The green conscious cars have to be bought between July 1st and November 1st of this year and incentives range from $3,500 to $4,500.

The trade-in vehicles has to follow certain terms to be deemed “tradable”.  Here are a few of requirements:

  • Must be drivable (can’t push it in)
  • Can get no more than 18 miles per gallon
  • Been built in 1984 or later
  • Have been owned (registered to) and insured by the purchaser for at least a year prior to the trade-in.

The miles per gallon rating refers to the Environmental Protection Agency’s combined city-highway rating of a given model.  Looks like the Geo Storm could have made it, except I’m pretty sure it got more than 18 miles per gallon.  That is as long as the engine didn’t overheat.

How the Cash for Clunkers Program Works

When you apply for the program, you initially will receive $3,500 voucher towards your new fuel saving vehicle. (Cha-ching!) The new vehicle must have a sale price of $45,000 or less and get at least 22 mpg.  The deal gets even sweeter if your vehicle is 10 mpg better than your gas guzzling hog (Think Toyota Prius).  If buying isn’t your thing, you can also use that towards a five-year lease of a vehicle with similar specs. Consumers won’t actually receive the vouchers or the cash value of the vouchers in hand. Instead, for a qualifying new vehicle,the government will transfer the funds electronically to the dealership where the vehicle is being purchased.  That dollar amount will then be credited towards all of part of the down payment.

Trade-In Value

The voucher value replaces the trade-in value, and does not add to the trade-in value. Whether you utilize the voucher program will depend upon the value of your trade-in vehicle. If its value is greater than the voucher, you probably will not want to take the voucher value for your old vehicle. On the other hand, if it is worth less, then you certainly will want the higher voucher value. A side benefit of using the voucher program is that you won’t have to negotiate the trade-in value with the dealer.

Also, keep in mind that under the voucher program the dealer cannot resell the trade-in and must have it scrapped. 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 can’t be used to offset a rebate or discount. Dealer participation in the program is voluntary, and those who do participate must register with the program.

Tax Consequences of the Cash For Clunkers Program

Worried about the tax consequences?  For any new government program, I would also be skeptical on the motives.  While I’m sure there are other motives, getting tax revenue directly from the vouchers is not one of them. The vouchers are not treated as taxable income. Think of the voucher value as taking the place of your trade-in value. However, if the trade-in vehicle has a greater market value than the voucher value, then it may not be to your financial benefit to utilize the voucher program unless the after-tax benefits are greater.  As usual, consult a tax professional to make sure what you choose is best for your situation.

The Tax-free Feature of the Vouchers

If you do take advantage of the tax-free feature of the vouchers, you will be subject to the following tax consequences:

Personal-Use Vehicle

Generally, there are no tax consequences related to selling or trading in your used vehicle since rarely is one sold for more than its original cost to the owner. Losses from the sale of personal-use property are not tax-deductible.  That’s that a little bit different from a the sell of devalued stock.

Business Vehicles

Since the voucher is not treated as income, a business that utilizes the voucher program is treated as if it traded in the old vehicle and received zero for it. Its basis in the new vehicle would be the amount paid net of the voucher and any other rebates.

For a business, trading in a qualifying vehicle with a low or zero depreciated basis definitely beats selling it for an amount equal to or less than the voucher’s value. In fact, it may even pay to forego a higher sales price and instead trade in the old vehicle to receive a tax-free voucher.

Example

A business paying tax at a rate of 40% sells a truck for $5,000, it would have $3,000 left after paying a $2,000 tax. If the business trades in the old truck and qualifies for a tax-free $4,500 voucher under the new program, it would be $1,500 ahead.

State Tax Rules Cash For Clunkers

Although there is no federal tax due on the voucher received, there is a possibility of a state sales tax on the Cash for Clunkers program.  It all depends on what state you reside.  Be sure to consult with a local tax advisor to see what tax implications you may have.

*Note: Cash for Clunkers is officially over.  If you still have a clunker and not sure what to do consider donating your car to charity, instead.

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