Back in March, Bonnie Monahan, vice-president of planning and business development at Timberland, decided to hurry up and trade in her 2000 Volkswagen Passat for a nifty new Toyota Highlander hybrid.

Monahan wanted to save money on gas and do her part to clean up the environment, but she decided to buy now rather than next year for financial reasons. The environmentally conscious Stratham (N.H.) shoe company she works for gives employees $3,000 for buying a hybrid. Also, she knew if she hurried she could get the full $2,200 federal tax credit on a Highlander hybrid before the tax breaks start phasing out this fall. All that made buying a Highlander now "a really hard thing to turn down," she says.

With some more tepid-selling hybrids, dealers are even offering discounts this year. When Monahan bought her Highlander in March, two Toyota dealers ended up competing for her business. On top of the $3,000 Timberland gave her and a $2,200 federal tax credit, the winning dealer took $3,719 off the hybrid's $40,719 list price -- lowering her net cost to just $31,800. Now, her husband is talking about replacing his minivan with a hybrid.

Monahan's experience illustrates a key point about the market for hybrids: How much you pay can depend on when you buy, where you live, and even where you work. And while it may take years for hybrids to pay off financially for many buyers, there are now numerous federal, state, and local incentives that can dramatically change the equation.

Click here for a slideshow on the Federal tax credits for different hybrid models.


On top of the federal tax break of as much as $3,150, for instance, the state of Colorado offers an additional tax break of $4,181 to $4,713 on a Honda Insight, $3,434 on a Toyota Prius, $2,156 to $2306 on a Honda Civic, and $2,758 to $2,797 on a Ford Escape or Mercury Mariner hybrid. West Virginia and New York, among other states, also have generous tax credits for hybrids. And Google and Hyperion Solutions, the Santa Clara (Calif.)-based software company, offer employees $5,000 toward the purchase of a high-mileage hybrid like the Prius or Civic.

The first thing to keep in mind if you want a hybrid -- especially a Toyota -- is that it may pay to place your order sooner rather than later. That's because federal government tax credits for buying a hybrid are scheduled to start gradually phasing out soon. Under the complicated federal rules for the phase-out, which are based on the volume of hybrids each company sells, the tax breaks on Toyota's hybrids are scheduled to diminish first -- starting in October, when they'll be cut in half.

Next April, the incentives on Toyota hybrids will drop to one-quarter of the current level, and in October, 2007, they'll drop to zero. That's because the phase-out starts after a manufacturer has sold 60,000 hybrids (beginning Jan. 1 of this year) and Toyota, which controls about 70% of the U.S. hybrid market, had already sold more than 60,000 hybrids by the end of May.


Other manufacturers, such as Honda, Ford, General Motors, and Nissan, sell far fewer hybrids, so the phase-out of the federal tax credit probably won't start on their models until next year or later. On June 7, Honda announced that customers who buy its 2006 hybrid models may be eligible for a tax credit of up to $2,100.

Of course, Congress could always extend the tax breaks for hybrids, a move supported by President Bush and environmental groups. But that's far from certain. And in the meantime, the federal tax credit can make hybrids a lot more affordable. How much you get varies according to which type of vehicle you buy, with the maximum being a tax break of $3,150 for a Prius.

The Union of Concerned Scientists calculates the federal tax break on other hybrid models at $1,450 on the Honda Insight (which is being phased out), $2,600 on the Highlander and Camry, $2,200 on the Lexus RX 400h, $1,950 to $2,600 on the Escape and Mariner, $1,700 to $2,100 on the Honda Civic, and $1,550 on the Lexus GS 450h.


The federal tax break is a small percentage of the selling price of an expensive model like the Lexus, but makes a big difference on less expensive models. Even though some dealers are charging a premium for the hot-selling Prius, for instance, the credit represents 12% of the car's current average selling price, which the Power Information Network calculates at $26,508.

The tax break amounts to 9% of the average selling price of the Camry hybrid ($29,373, according to Power), up to 8.9% of the Civic hybrid's $23,717 average price, and up to 8.7% for the Escape's $29,964 average price. And if you happen to live in Colorado or West Virginia, the combined state and federal tax credit amounts to as much as a quarter of the price of some models.

Tax subsidies, however, are far from the only incentives being offered on hybrids. For instance, a major reason metropolitan Washington, D.C., is one of the biggest markets for hybrids is that hybrids get special access to commuter lanes. California, New Jersey, and Arizona, among other states, also allow hybrids special access to commuter lanes, though a permit is required and the benefit is usually restricted to high-mileage/low-emission models like the Insight, Civic, and Prius.


When video writer and producer David Pool moved with his family from Orlando to Albuquerque, he discovered another benefit: His 2004 Prius qualified for free parking in his new hometown. Los Angeles, San Jose, Aspen, and New Haven, among other cities, also offer free parking for hybrids, while some lots in Baltimore offer big discounts. Some companies also give hybrid owners preferential parking. At Timberland, Monahan notes, "even executives don't get a special parking space -- unless they own a hybrid."

Numerous other state and local incentives, ranging from additional sales and income-tax credits to reduced vehicle license fees, have been passed or are being considered by different states and localities. Check out incentives for hybrid vehicles in your area at, a Web site developed by the Union of Concerned Scientists.

It's not clear, however, how important the incentives are in promoting sales. At Toyota, Celeste Migliore, national manager for alternative fuel vehicle marketing, predicts that the phase-out of federal tax credits "won't affect hybrid sales at all." That's partly because the alternative minimum tax means that the majority of buyers of more expensive models like the Highlander and Lexus RX 400h don't qualify for the federal tax break anyway, Migliore says.


And less expensive models such as the Prius and the new Camry hybrid are in such high demand that Toyota probably can sell as many as it can produce for the time being. Prius sales are actually down 12% so far this year, to 38,460 -- not because of lack of demand but because phasing in the new Camry hybrid has slowed production and there are hardly any Priuses on dealers' lots.

Incentives can play a role, notes Eric Peterson, marketing manager for the Mercury Mariner, "but that's not why a lot of customers buy the vehicle." For one thing, buyers of the Mariner hybrid tend to be older (52 on average) and more affluent than buyers of the conventional Mariner, he says. Price also isn't the first priority of many buyers.

Pool, for instance, says the tax break he got was "gravy" but the main reason he and his wife bought a Prius is that "we are in favor of the technology, and we wanted to vote with our wallet in support of any company with the courage to support the technology." Adds John Gordon, a retired Pennsylvania manufacturing entrepreneur: "We knew about the tax credit but we bought our Prius for the gas mileage and because we wanted to make a statement [about the environment]."


However, the incentives may play a more important role as more of them are introduced and people learn more about them. Barbara Gref, editor of the Towne Crier newspaper in Livingston Manor, N.Y., says when she bought her 2003 Civic hybrid the dealer didn't even know about the state and federal tax breaks she would get. And the Internal Revenue Service tried to disallow the deduction she took on her taxes.

"They said I had made a terrible mistake and owed more money," she recalls. "I had to talk to three people at the IRS before one of them finally looked closely at the rules and said, ‘Hey, you're right.'" Those days of general ignorance are rapidly receding into the past.

Click here for a slideshow on the Federal tax credits for different hybrid models.

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