Deduct While You Can

The sales tax deduction is back ... for now, at least. As I pointed out in an earlier article, the new tax changes allowed for a deduction for sales taxes in 2004. Many folks are still unclear on how to apply it, though. Here are a few frequently asked questions:

Q. Can I deduct my sales taxes?
A. You're allowed to deduct either your sales tax or your state income tax, whichever is greater. If you live in a state that imposes no personal income tax, this is a brand-new deduction for 2004 that will save you tax dollars immediately if you itemize your deductions.

Q. If I live in a state with income taxes, should I just ignore the sales tax deduction?
A. Absolutely not. While those living in states with no income tax (including Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) will receive the greatest benefit, many taxpayers residing in states that assess a low to moderate income tax will also benefit. If your income and state tax rates are modest, it's quite possible that the sales tax deduction will be greater of the two.

Q. How is the sales tax deduction computed?
A. The IRS has issued tables (found in IRS Publication 600) that provide the amount of anticipated sales taxes that you paid, given your income level. Of course, if you are inclined to keep all of your sales tax records, you can deduct the actual sales tax that you pay rather than using the IRS tables.

Q. What about "big-ticket" items?
A. The IRS allows you to add to the deduction allowed by the table with actual sales taxes paid on several specific larger purchases:

  • Vehicles (either purchased or leased), including trucks, vans, boats, and aircraft
  • Motor homes and recreational vehicles
  • Homebuilding materials
  • Homes, including mobile and prefabricated homes

But if you're considering purchasing that full-blown home entertainment system with the oversized plasma TV to take advantage of the sales tax deduction, think again. Those items would certainly qualify as "big-ticket," but they're not on the IRS' list, and can't be added to any deductions from the IRS' tables.

Q. Should I consider claiming the sales tax deduction instead of my state tax deduction if they are virtually the same?
A. You might. Because of the tax benefit rule, any state tax refunds you receive are generally taxed on your federal return the following year. Sales tax deductions aren't. Since either deduction will have the same effect on your federal taxes, you might consider taking the sales tax deduction to save a few more bucks the next time April 15 rolls around.

Q. Can I also claim city or local sales taxes?
A. Absolutely. Publication 600 has a formula which will allow you to compute your city and/or local sales taxes and add them to your state tax table amount, thereby increasing your sales tax deduction by those amounts.

Q. What if I lived in more than one state during the year -- states with different sales tax rates? Do I have to choose a state for my deduction?
A. Not at all. Publication 600 also provides information on how to prorate your sales tax deduction over the two states in order to get the maximum benefit.

Q. When can I use this deduction?
A. It was first allowed for the 2004 tax year, and is scheduled to expire after the 2005 tax year. For one brief, shining moment, we have a new deduction. Don't overlook it.

Roy Lewis lives in a trailer down by the river. When he's not dealing with tax issues, he's a motivational speaker. He understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.

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