State sales taxes can still cut your IRS bill

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The good news is that with the state sales tax deduction, you can count amounts you paid last year on retail purchases to possibly help cut your 2007 tax bill.

There’s some bad news, though. When this year began, this popular tax break expired, so it’s up to Congress to decide whether to continue this tax break in 2008. Watch “Tax changes for 2008”

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 you’ll find in the sales tax tables, found this year in IRS Publication 600. 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
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 foregoing their normal income tax deduction, but until there’s a little more clarity on just how the deduction will work, it’s hard to know for certain,” says Mark Luscombe, attorney, CPA, and principal federal tax analyst for tax publisher CCH Inc. of Riverwoods, Ill.

Freelance writer Kay Bell writes Bankrate’s tax stories from her Austin, Texas, home. She also writes two tax blogs, Bankrate’s Eye on the IRS, and Don’t Mess With Taxes.

— Updated: Jan. 14, 2008