FAQ: How does the new sales tax deduction for vehicle purchases work?

Non-itemizers and itemizers alike who purchase a new vehicle in 2009 may be eligible for a new (but temporary) above-the-line deduction for the state and local sales taxes or excise taxes paid on the purchase. This temporary tax break is part of the American Recovery and Reinvestment Tax Act of 2009 (2009 Recovery Act).

General rules

The motor vehicle sales tax deduction is treated as an increase in the standard deduction (or as a “bonus” standard deduction for those taking itemized deductions). The deduction for state sales and excise taxes paid on a new motor vehicle is allowed for purchases made between February 17, 2009 and before January 1, 2010. The amount of the deduction allowable cannot exceed the part of the state sales or excise tax imposed on the first $49,500 of the vehicle’s purchase price. Eligible taxpayers may claim the deduction in determining their regular income tax and alternative minimum tax (AMT) liability.

Traditionally, one reason to sell your trade-in vehicle to the dealer from whom you are purchasing your new one is that state sales tax laws generally allow sales tax to be paid only on the net purchase price (that is, less the trade-in). While it remains more advantageous to avoid sales tax rather than take a deduction for it, this difference may be one more reason to donate your trade-in to charity. We can crunch the numbers to help you make a final decision.

However, the deduction begins to phase out for individuals with adjusted gross income (AGI) exceeding $125,000 ($250,000 for joint filers) and is completely phased out when an individual’s AGI exceeds $135,000 ($260,000 for joint filers). Additionally, the deduction can not be claimed for sales taxes paid on leased vehicles.

Vehicle limits

The deduction is only allowed for “qualified motor vehicles.” For purposes of the deduction, a “qualified motor vehicle” is any newly purchased vehicle, including cars, SUVs, light trucks, or motorcycles that are first used by the taxpayer. Used cars are not eligible for the deduction. But, both domestic and foreign-made vehicles qualify. Generally, the qualifying vehicles cannot weigh more than 8,500 gross pounds.

Example. You have purchased a new car that qualifies for the vehicle sales tax deduction. Your AGI is less than $125,000, so you qualify for the full amount of the deduction. The car cost $40,000 and the sales tax paid was 4 percent. Your above-the-line deduction would be $1,600, which if you are in the 25 percent income tax bracket is $400 more in your pocket because of your vehicle purchase.