1 Tax Break You Need to Know About

Many people know to deduct their state income taxes every year, but there's another deduction that might be worth more.

Matthew Frankel, CFP
Matthew Frankel, CFP
Feb 8, 2015 at 5:02PM
Investment Planning

Source: 401kcalculator.org via Flickr.

When you file your taxes, the IRS lets you take a Federal deduction for your state income taxes if you itemize, which can be worth a lot of money depending on where you live and how much money you make. However, this tax break doesn't help people who live in income tax-free states.

Fortunately, the IRS allows you to substitute the state sales taxes you paid throughout the year. Let's go over how you calculate this deduction and how much it could potentially cut from your tax bill.

You can deduct the greater of the two
The IRS allows taxpayers who itemize deductions to deduct the greater of their state income tax or the state sales tax they paid throughout the year. For many people, state income tax is by far the higher of the two.

However, there are seven states that don't have an income tax and another two that don't tax wages:

States With No Income Tax States With No Wage Tax
Alaska Tennessee
Florida New Hampshire
South Dakota  

For residents of these states, deducting state sales tax is a no-brainer. Think of how much money you spend throughout the year. The small amount of sales tax tacked on to every purchase can really add up.

Even if your state does levy an income tax, you should compare the two deductions to see which one would save you more. For example, deducting state sales tax could be the more lucrative option if you happen to have a lot of deductions and credits that bring down your state income tax, or if you bought a few expensive items last year.

This sounds complicated, right?
At first, this deduction may sound like more trouble than it's worth. After all, who has the time, patience, and receipts necessary to figure out exactly how much they paid in sales taxes last year?

Luckily, there's an easy method to estimate your deduction. The IRS provides a calculator that can tell you how much of a deduction to expect based on your income and state of residence. It also factors in big-ticket purchases that had state sales tax added on, like vehicles and home renovations. These purchases are in addition to the standard sales tax deduction the IRS calculator comes up with. Make sure you save your documentation for these purchases, as you'll be required to submit copies to the IRS if you're claiming sales taxes beyond the calculated amount.

How much it could save you
As an example, I ran a quick calculation for a married couple in Miami, Fla. (6% state sales tax and 1% local tax) who have no children and make a combined $100,000 per year. According to the IRS calculator, the state sales tax deduction is calculated at $1,214.50. That's a pretty substantial amount, and it could be even higher if the couple bought something like a boat or a car during the year.

So, this deduction is no small potatoes and could save you hundreds or even thousands on your taxes, depending on your income, family situation, and marginal tax rate. And the best part is that by simply typing in a few numbers on an IRS calculator, you can figure out just how much of a deduction you're entitled to. Even if you don't live in a "no income tax" state, it can be well worth the few seconds it takes to compare the two deductions.