Maximize your client's sales tax deduction with these valuable tips.
July 16, 2009
by Mark Washburn, CPA/MST
The passage of the American Jobs Creation Act of 2004 (AJCA of 2004) created a new deduction for individuals who could itemize their deductions. More accurately, this act reinstated Section 164(b)(5) of the Internal Revenue Code allowing a deduction of state and local general sales taxes in lieu of a deduction for state and local income taxes. This act initially authorized this deduction for tax years 2004 and 2005. However, Congress has renewed it each subsequent time it was set to expire. New provisions for 2009 will be discussed later.
Seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming) do not impose state and local income taxes on their citizens. Citizens living in the other 43 states are able to include as a deduction on Schedule A the amount withheld from wages for state and local income taxes. The passage of the AJCA of 2004 gives individual taxpayers a choice of deducting — whichever is greater — the state and local withholding taxes on income or state and local general sales taxes paid (incurred, for accrual method taxpayers).
To be eligible for this deduction, a taxpayer must be able to itemize their deductions using Schedule A. As with any other Schedule A itemized deductions, taxpayers whose deductions do not exceed the standard deduction will have a better outcome on their tax return by using the standard deduction amount. In order to claim the deduction for state and local general sales taxes, the law allows two different methods of determining the amount of the deduction. Under the actual expenses method, an individual must have documentation supporting the amount of deduction claimed. If the taxpayer has not kept sufficient documentation to support his claim, he may use the optional sales tax tables provided by the Internal Revenue Service (IRS). These tables, as well as a worksheet for determining the deduction, can be found as part of the instructions for Schedule A.
Understanding Optional Sales Tax Method
As most taxpayers will not sufficiently keep adequate records allowing for use of the actual expenses method, understanding the optional sales tax method is crucial in order to minimize the tax burden on an individual. The IRS has structured tables for each of the 50 states based on the general sales tax imposed by each state. The table is arranged in a grid, with a number of exemptions along the horizontal axis and modified adjusted gross income (AGI) along the vertical axis. To determine the amount of deduction for a particular taxpayer, simply locate the relevant modified AGI range then read across, stopping in the column for the number of personal and dependent exemptions claimed on the tax return. The amount at this intersection represents the amount of general sales tax imposed by the state. Remember, local general sales taxes are also deductible, but are not shown on the optional sales tax tables due to wide variations in each state
for these amounts. Use the state and local general sales tax deduction worksheet to calculate the deduction if local general sales taxes are imposed where you live.
Pretty straightforward, you say. But consider the following. The optional sales tax tables provided by the IRS are intended to approximate sales taxes paid (incurred) on everyday purchases based on a range of income and family size. What happens when your annual purchases include a "big ticket" item such as a new car or recreational vehicle? Sales taxes on such items alone might exceed the amount allowable using the IRS optional sales tax tables. Is there any remedy for such circumstances?
Fortunately, the answer is yes. Internal Revenue Code Section 164(b)(5) allows taxpayers using the optional sales tax tables to add the sales taxes paid (incurred) on certain big-ticket items to the amount provided by the tables. The sales taxes on certain items such as motor vehicles, aircraft, boats and mobile or prefabricated homes can be added to the optional sales tax table amount to arrive at your total deduction. Certain restrictions do apply, as the amount of these taxes cannot exceed the amount that would be due using the allowable state general sales tax rate, so you must make the effort to determine the rate paid (incurred) by your client if they have made such a purchase and want to include it for this deduction.
Certain other issues may influence this deduction as well. In order to maximize the amount of the deduction, you must understand how to modify the AGI from Line 38 in Form 1040. Certain tax-exempt income — including but not limited to the following — must be added back to the Line 38 AGI to arrive at the proper modified AGI: tax-exempt interest, nontaxable combat pay and nontaxable parts of Social Security or railroad retirement benefits. See Schedule A instructions or Publication 600 for complete details on how to modify AGI.
Married taxpayers using the married filing separately filing status are subject to special rules. If each spouse elects to itemize his/her deductions and both claim the sales tax deduction, both must use the same method to claim the deduction. In other words, they must both use the actual expenses method or both use the optional sales tax tables.
Taxpayers claiming the sales tax deduction may be subject to the alternative minimum tax (AMT) provisions, effectively eliminating the benefit on their regular income tax.
The rules change somewhat for tax year 2009. As a result of the American Recovery and Reinvestment Act of 2009. taxpayers will be able to claim a deduction for state and local general sales taxes and excise taxes paid on the purchase of new (not used) cars, light trucks, motor-homes and motorcycles even if they are not able to itemize their deductions. Purchases of the qualifying items mentioned above must have been made after February 2009 and before January 2010. Further, the deduction is phased out for single taxpayers with income above $135,000 and married filing jointly taxpayers with income above $260,000.