‘Cash for clunkers’ and taxes

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The ‘cash for clunkers’ program, which kicked into gear over the weekend, is raising a couple of taxing issues for potential car buyers.

The program can lower the price of a new vehicle by $3,500 or $4,500, depending on the improvement in fuel economy versus the vehicle the buyer is trading in. Which raises the question: Are state and local sales taxes applied before or after the price reduction?

After, according to state tax officials. That would result in additional savings. For example, in Los Angeles, where the sales tax rate is 9.75%, lopping $3,500 off the purchase price of a vehicle would save a qualifying buyer $341.25 in sales tax.

The ‘cash for clunkers’ law specifically states that the cost savings aren’t considered income for the buyer and are not subject to federal income taxes. But the situation is a less clear for dealers, who are worried that they may have to pay income tax on any money they receive under the program.

California residents, meanwhile, may face a tax bite from Sacramento. If the price reduction on the new car is greater than the amount the buyer paid for the “clunker” in the first place, the difference has to be reported as a taxable gain and the buyer may have to pay state tax on it, according to the state Franchise Tax Board.

For example, if a person trades in a vehicle that cost $3,000 and qualifies for a $3,500 price reduction, that person has to report the $500 difference as a taxable gain.

-- Martin Zimmerman