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| The Basics | Yes, you can deduct sales taxes this year
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This is great news if you live in a state that has no income tax. It might be good if you live elsewhere; here's how to find out.
By Jeff Schnepper
If you live in Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington or Wyoming, rejoice! You just got a major new tax break.
Those states don't have a state income tax. So, residents of those states never got an itemized deduction on their federal returns for state income taxes paid. Of course, on the other hand, they never actually paid any state income tax.
Personally, I'd give up my real-estate tax deduction if I didn't have to pay the taxes in the first place. But let's not get too deep into the quagmire of "fairness" in the Internal Revenue Code.
In an attempt to create equity between taxpayers in those states and taxpayers who were able to take a state income tax deduction, Congress last year created a new sales tax deduction for 2004 and 2005. Whether Congress will extend the break after the 2005 tax year is anyone's guess. But if you're for extending the break, write your Congressman.
A few strings attached . . .
Now taxpayers, regardless of where they live, can deduct any state and local sales tax paid in lieu of deducting their state and local income tax. But there are strings attached to this deduction:- There is no double dipping allowed. You can't deduct the sales tax and the income tax.
- You must itemize your deductions. Or you get nothing from the new law.
There is some flexibility on your 2005 return. See which produces the bigger deduction: The sales tax deduction or the income tax deduction.
Actual receipts vs. the IRS sales tax table
Clearly, you should deduct the expense that gives you the biggest tax break. State and local income taxes are easy to compute. Look at your W-2. It will show any state and local income tax withheld. Add to that any estimated payments and any state and local income tax paid in 2005 on 2004 tax returns that were actually filed in 2005.
That's the number your sales tax deduction has to beat.
Computing your sales tax is a bit more complicated. If you saved all your receipts and can total your sales tax paid for the year, then it's easy. But if you savd your sales tax receipts for the year, including the months before the provision for the deduction was passed by Congress, you probably have other issues. . .
Most people will use the optional state sales tax tables published by the IRS in Publication 600. (To download the publication, click here.)
The tables are based on your adjusted gross income -- line 37 on your 1040 tax form.
But you add to that number certain nontaxable items such as tax-exempt interest, veterans' benefits, nontaxable combat pay, workers' compensation, nontaxable Social Security and railroad retirement benefits, nontaxable IRA, pension or annuity distributions, and any public assistance payments.
The higher your "income," the greater the deduction. The more exemptions you claim, the greater the deduction.
Don't forget the local taxes!
But, we're not done yet! In addition to the table amount for state sales tax, you get to deduct:
Local general sales taxes. This applies if your locality imposes a general sales tax.
Any state and local sales tax paid on specific items. These include: Motor vehicles. This includes cars, motorcycles, motor homes, recreational vehicles, sport utility vehicles, trucks, vans and off-road vehicles. You can include any state and local general sales taxes paid for a leased vehicle as well.
Aircrafts, boats, homes (including mobile and prefabricated) or home-building materials. The deduction would apply if the tax rate was the same as the general sales tax rate. If you lived in more than one state, you take a percentage for each state depending on the number of months you were there. So, if you lived in New Jersey for three months and Pennsylvania for nine months, you can deduct 25% of the New Jersey table amount plus 75% of the Pennsylvania table amount.
So, here's how you now have to compute your tax:- Decide if you're better off itemizing or going with the standard deduction.
- If you're itemizing and live in one of the 42 states where there's a state income tax, decide if the state income tax or sales tax generates the larger potential deduction.
- Decide whether to use your actual receipts or the adjusted table amounts provided by the IRS. To calculate the local portion of the sales tax deduction, fill out the worksheet that comes with Publication 600.
How to calculate the local sales tax deduction
You calculate your local sales-tax deduction by calculating the ratio of your local taxing districts vs. the state rate. You multiply your state sales tax deduction by that rate.
Let's say you claim four exemptions, and your adjusted gross income comes to $80,000. You live in Iowa, which has a 5% statewide sales tax, and your local community tacks on another 2%. Your state sales tax deduction is $902.
To figure the local portion of the deduction, divide the local rate by the state rate. In this case, it comes to 0.4. Multiply that number by $902, which is $360.80. Add $902 and $360.80 for a total deduction of $1,262.80.
And don't forget the AMT
When you're done, check to see whether you've been bumped into the dreaded alternative minimum tax, or AMT. Taxes paid are a preference item for the AMT. The more taxes you deduct, the better the odds this alternative tax will bite you.
Congress gives with one hand, and takes with the other. Remember, we decided not to get into the concept of "fairness."
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