Understanding the Tax on Car Purchases: What You Need to Know

You may experience sticker shock when you see a car's final price. Here's what you should know about tax when you buy a car.

Lance Cothern | 

Feb 4, 2022 | 4 min read

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Whether you're looking at the price online, on a car's window sticker, or you've negotiated a deal, you may feel surprised when you see the final purchase price of your car. Several states charge sales tax on car purchases (or other similar taxes), which may result in an overall higher cost than you might expect.

To avoid this shock, here's what you should know about the car taxes you may encounter when purchasing a vehicle.

Taxes Vary by State

Thanks to the power of the internet, you can purchase a car virtually in almost any state. This may allow you to find the best purchase price. While you might think purchasing a car in another state with lower sales taxes could help you save money, that's not always the case.

Ultimately, this may be determined by where your car is registered or where your car is used. The specific taxes you pay can vary by state and locality.

Depending on your location, these are the different taxes you may have to pay after buying a car:

• Sales tax: The most well-known name for taxes paid on car sales is the sales tax. No matter where you buy your vehicle, you pay the same tax rates as the sales tax you pay on other transactions in your locality. That said, some states and localities may use different rules for large transactions, such as purchasing a car.
• Excise taxes: A handful of states use the term "excise tax" for their particular tax. The District of Columbia bases its excise tax on car weight and the car's mpg fuel efficiency rating, exceptions to this standard to apply. Other states, such as New Mexico and North Dakota, generally have a flat rate motor vehicle excise tax. New Mexico's tax is due every time a vehicle is titled, and North Dakota's tax is due at the time of sale or first registration after a sale.
• Title taxes: Maryland and Georgia call them title taxes rather than sales taxes. Georgia's title ad valorem tax is 7%, while Maryland's titling tax is 6%.
• Other tax names: Other names for taxes exist in some states. For instance, Delaware has a motor vehicle document fee each time the title transfers, Iowa has a one-time registration fee whenever a vehicle is transferred to a new individual, and Kentucky has a motor vehicle usage tax whenever ownership is transferred.

How to Calculate the Taxable Amount

The taxable amount of a car sale may change depending on the state you live in. These state taxes may also vary depending on whether you trade in a vehicle or decide to lease a car instead of buying a car outright.

Many states, like Texas for example, allow you to reduce the taxable amount of the purchase by the amount you receive in trade-in credit. If you purchase a new car for $30,000 and receive $10,000 in credit on your trade-in, you may only have to pay sales tax on the $20,000 difference. However, a select few states, such as Virginia, charge tax based on the entire sales price of the vehicle. Based on the previous example, this methodology may require you to pay tax on the full $30,000 purchase price.

States may limit the amount of the purchase price for which you have to pay certain taxes. For instance, Florida's locality-based sales taxes only apply to the first $5,000 of the purchase price, while the 6% state portion of the tax applies to the entire purchase price.

Leasing often has special sales tax rules. Many states only charge sales tax on the lease payment amount each month. Others may charge sales tax on the total price of the leased vehicle.

Some state-specific irregularities may apply to your situation. Check with your state's and locality's tax laws to determine exactly how much of the purchase price you'll have to pay the applicable taxes on. This way, you can budget for this expense properly.

Paying Relevant Taxes

In some cases, the car dealership may collect any sales taxes owed at the time of the sale and remit them to the proper authorities. This collection of sales or other similar taxes can add to the negotiated price of the car. As a result, buyers may experience sticker shock, having already negotiated for a lower price.

Even if an out-of-state dealership doesn't collect your state's sales taxes, you still must pay them when you register your car. This could catch you by surprise if you thought you finished paying for your new vehicle.

Consult a Local Tax Expert

A great way to prepare for the tax on car purchase transactions is by consulting an expert. Check with your state and local tax agencies or your local department of motor vehicles to find out which taxes you may need to pay and how to calculate them. A car dealership may point you to relevant resources, but you should always verify all information before finalizing a large purchase.

Lance Cothern

I started reading everything I could about personal finance while I attended college. It turns out that was one of the smartest decisions I could have made. Now, I want to share that knowledge with you. Using what I've learned through my education and experience, I aim to help you make informed decisions throughout the car buying and lending process while saving money at the same time.