State sales taxes can cut your IRS bill

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The good news is that the state sales tax deduction is still in effect, meaning you can count amounts you paid last year on retail purchases to possibly help cut your 2008 tax bill.

The better news is that last fall when Congress retroactively reauthorized this tax break for the 2008 tax year, it extended the deduction through 2009, too.

There is, however, a bit of bad news. Technically, this deduction still is temporary. Unless Congress decides this year to continue it in 2010 or beyond, taxpayers could soon lose the value of this itemized tax break.

Many taxpayers find that by itemizing they can deduct enough in sales taxes paid to make a difference in their IRS bill.

To claim this tax break on your 2008 return, you must:
  • Consider whether to deduct your state income or sales taxes.
  • Determine whether to use the IRS-calculated amount for your state and filing status, or add up all your separate sales tax receipts.
  • Figure out how much local sales taxes you can count.
  • Add in the sales tax amounts charged on autos, boats or homes.

But while we can still claim it, let’s examine whether the sales tax deduction can reduce what you owe Uncle Sam.

Making a tax choice

The first thing to note is that this deduction isn’t an add-on; it will require you to choose. You must decide whether you want to deduct the sales taxes you paid or your state income tax amounts.

The choice is obvious for residents of the seven states that do not collect state income taxes but do levy state sales taxes: Florida, Nevada, South Dakota, Texas, Washington, Wyoming and Tennessee, which taxes only dividend and interest income.

The measure also allows for deductions of local sales taxes. This again benefits residents who pay local sales taxes in the non-income tax states, as well as some Alaska residents. Alaska has no individual income or state sales tax, but some jurisdictions do charge local sales taxes. New Hampshire also lacks an income tax (like Tennessee, it taxes interest and dividend income) or a state sales tax, but it does charge consumers a tax on meals and room and vehicle rentals.

While the provision will be a decided boon to residents of non-income tax states, congressional aide Sarah Stephens notes that the new tax break is available to residents of all states where sales taxes are imposed.

“All taxpayers will get the chance to choose which deduction to take,” says Stephens, district director to Rep. Kevin Brady, D-Texas, who was one of the original backers of the law when it was first enacted back in 2004. “Basically, it will be up to the individuals to do the math and see which deduction, state income taxes or sales taxes, will save them more.”

Figuring your sales-tax break

The sales tax deduction will be available to filers who choose to itemize their expenses on Schedule A. And they will have two ways to determine just how big their sales tax deduction will be.

You can claim the total sales taxes you actually paid based on the amounts shown on your receipts. Just be sure to hang onto those register tapes in case the Internal Revenue Service has a question about how you arrived at your deduction amount.

Or you can claim the amount in the sales tax tables, found in the Form 1040 Schedule A instructions. Because sales tax rates vary from state to state, the Treasury Department and IRS have come up with different tables for each.

The sales tax deduction tables are based on the average consumption by taxpayers, taking into account filing status, number of dependents, adjusted gross income and rates of state and local general sales taxation.

Most taxpayers probably will opt for the ease of using the deduction amount provided in the official tables. But taxpayers should make sure they use the sales-tax deduction that gives them the biggest break.

“Every family would be a little different,” says Stephens. “A family with a new baby might spend a tremendous amount of money outfitting a new nursery and find that they’re better off adding up their actual sales tax receipts. They could look at the table and say ‘We get a $450 deduction, but we’ve got receipts for $500.'”

Added sales tax break for cars, boats and homes

There’s also a combination option, notes Stephens, that could help consumers who purchased, and paid a hefty sales tax, on a car or boat. In these cases, taxpayers can claim the average sales tax deduction from the tables and then also add in the tax on the road or marine vehicle.

“It’s conceivable that people who buy a car in a location with a high sales tax and moderate state income tax would do better by forgoing their normal income tax deduction,” says Mark Luscombe, attorney, CPA and principal federal tax analyst for tax publisher CCH Inc. of Riverwoods, Ill.

The stimulus measure enacted in February also includes an automotive sales tax write-off which can be claimed without itemizing. But that new tax break applies to 2009 vehicle purchases. For 2008 filing purposes, you’ll still need to file Schedule A and add in your vehicle’s sales tax amount.

Sales taxes on the purchase of a home, including a mobile home or a prefabricated residence, also can be counted in addition to the table amount as long as the sales tax rate is the same as your state’s general levy on purchased goods. The same is true for the sales taxes applied to the cost of a substantial renovation of or addition to your home.

To figure the total amount of allowable state, local and specific additional sales taxes you can deduct, you’ll need to fill out a work sheet found in the Schedule A instructions. If you use tax preparation software, the computations should be made there. Or you can use the IRS’s online sales tax deduction calculator.