Sales Tax Deduction Is Back--With a Catch
Big spenders, start saving your receipts.
The recently passed American Jobs Creation Act of 2004 includes a provision that gives taxpayers who itemize deductions a choice: They can write off the state income taxes they pay, or they can choose to claim their sales taxes instead.
This new tax break was pushed by members of Congress in states without income taxes, who saw it as a way of getting their residents an added deduction. But it also has potential for big spenders in California, which has both relatively high sales tax and high income tax rates. The catch: To get any real mileage out of the deduction, taxpayers may need to maintain a shoe box full of receipts.
Clint Stretch, director of tax policy with Deloitte & Touche in Washington, said this provision would have the most effect in the seven states that either have no income tax or assess taxes only on dividends and interest.
“But someone in a state like California might want to consider this if they had low income but high wealth, so they found themselves buying a luxury car or boat in a year that they didn’t pay a lot of income tax,” he said.
For instance, a family of four with $50,000 in taxable income would pay $1,263 in California income taxes. The family, assuming it had fairly standard expenses, would be unlikely to have bought enough taxable goods to make the sales tax write-off worthwhile, said John Logan, senior state tax analyst with CCH Inc., a Riverwoods, Ill.-based publisher of tax information.
But not always. If this family decided to tap its savings to buy a $40,000 car, the situation would reverse. In Los Angeles County, the family would pay $3,300 in state and local sales taxes on that purchase alone. Add that to other taxable purchases, and the sales tax write-off is likely to be twice as valuable as the income tax deduction, Logan said.
In Illinois, where the income tax rate is relatively low but state and local sales taxes can exceed 8%, most families will benefit from writing off the sales tax rather than income taxes, Logan added.
Of course, individual circumstances vary, so taxpayers should look closely at their own situations before deciding which option to take and consult a tax advisor if necessary.
The sales tax deduction is a blast from the past, experts note. Twenty years ago, taxpayers were able to deduct both income taxes and sales taxes, so savvy taxpayers regularly kept track of their purchases. But the Tax Reform Act of 1986 eliminated write-offs for sales taxes.
This law is a bit more complex than the pre-1986 rules, because taxpayers must make a choice. They cannot deduct both income and sales taxes; they must choose one or the other. Ideally, taxpayers would figure out which tax nets the best deduction. But doing that can require some work.
Then, too, the deduction went into effect for the 2004 tax year, but most taxpayers probably didn’t see the law coming and might not have saved receipts from earlier in the year to substantiate the deduction, Stretch noted.
Taxpayers will have two ways to figure their sales tax deductions: They can save every taxable receipt from the year and add up all the tax charges, or they can take a flat deduction that varies based on income and household size.
The IRS is expected to publish tables by the end of the year so that taxpayers can determine what their flat deduction will be. Although the tables are not yet available, they are expected to be similar to those the IRS published in the mid-'80s.
Using those tables, for instance, a California family of four with $40,000 to $50,000 in income would be able to deduct $620 in sales taxes.
There are two things to remember if you opt to take the flat deduction. First, the IRS tables are expected to show only the amount of deductions based on the base sales tax rate imposed by the state. Many local governments impose additional sales taxes.
The pre-1986 tables included 15 footnotes, some as simple as “Local taxes are not included. Add the amount paid.” In other cases, the footnote would specify which types of taxes were not included, such as those imposed on electricity or natural gas.
In other cases, taxpayers would have to do some math to get their full deduction. The California sales tax rate is 6.25%, but the rate in Los Angeles County is 8.25% -- or 32% more. Consequently, a Los Angeles County resident would multiply the figure in the chart by 132%.
In the example above, the family of four would get a deduction of $818 in Los Angeles County, rather than $620 under the base state rate.
Even if you opt for the flat deduction, however, you will still be able to itemize -- or add on -- the sales tax you pay if you buy an automobile or boat. So the L.A. family of four would be able to add $3,300 to its $818 deduction if it buys the $40,000 car. But the extra deduction is limited to an automobile or a boat -- other big-ticket purchases, such as an airplane or a dining room set, won’t qualify.
If a family has large expenditures other than a car or a boat, it’s probably better off tracking the sales tax paid on every purchase. The catch here is that the taxes paid may not be readily apparent with some items.
For instance, those building a house may pay copious sales taxes for building materials and appliances. However, because sales taxes were not deductible in the past, the contractor might simply lump the taxes together with the cost of the items. Those hoping to use the deduction might need to ask the contractor to break out the sales tax charges, Logan said.
The law also creates an opportunity for those willing to plan, Logan said. Smart shoppers can now “bunch” big purchases, just as some taxpayers bunch other itemized deductions.
“If you know that you are going to be purchasing a car and doing major work on your house, you might want to consider doing both of those in the same year,” Logan said. “You could create a situation where you could take advantage of the sales tax in one year and go back to using the income tax deduction when you are back to your normal spending patterns.”
Kathy M. Kristof, author of “Investing 101" and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy .firstname.lastname@example.org.