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New Math for Tax Deductions

Tracy Byrnes

You charge away on your credit card to rack up frequent flier miles, only to find out you can't use them because of those insidious blackout dates.

Well, good news. Now you can get something a bit more useful for all that money you spent.

A tax deduction.

That's right. The sales tax deduction is back. Eliminated by Congress back in 1986, it's temporarily available again for 2004 and 2005.

So if you itemize your deductions on your tax return, start tallying those receipts.

The Option Is Yours

When you itemize, you can deduct things like mortgage interest, real estate taxes and charitable contributions on Schedule A -- Itemized Deductions. You also get to deduct any state and local income taxes you paid in that year.

And for folks in states like New York, that's a pretty big deduction. But for taxpayers in, say, Florida, where there is no state or local income tax, that line on Schedule A is blank.

Now, thanks to the American Jobs Creation Bill of 2004, and much lobbying by the congressmen and senators in states without state income tax, you have a choice. You can deduct either your state and local income taxes or your total sales tax paid.

Big note: You can't take both.

Typically, you would chose whichever is higher, but there are other considerations.

Depending on where you live, this may be a home run for you. Folks in places like Texas, where there is no state income tax and plenty of sales tax, will have no problems deciding how to play the tax deduction game. Same goes for Illinois residents, says John Logan, a state tax expert with CCH Inc., which provides tax and business law information.

And if you live in a state like Connecticut, where the income tax is actually pretty low, your sales tax expenditures may be higher.

But if you're in Alaska, this new law doesn't help you much. Not only is there no state tax in Alaska, there is no state sales tax either, says Jackie Perlman, a senior tax research analyst at H&R Block. There's a local sales tax for folks in a few cities, so some may benefit.

Some retirees may benefit, regardless of where they reside. That's because most states exempt pension income from state taxes, says William E. Massey, a senior tax analyst at RIA, a Thomson business providing tax information and software to tax professionals. So if they don't pay state tax on pension income, their state tax bill might be fairly low. But if they're spending money in their golden years, then their sales-tax-paid number could be higher.

So you now have another reason to keep everyday receipts -- not that it will help you for 2004 tax purposes, unless you bought big-ticket items such as an engagement ring or furniture or put in a media room and stocked it with equipment.

Since the tax law was passed retroactively, the IRS created Publication 600 -- Optional State Sales Tax Tables to help. These tables take into account things like your filing status and the number of exemptions you claim and offer a best guess of what someone in your tax position would probably have spent on sales tax. You'll have to do a quick calculation, but then you'll have an estimated sales-tax-paid number.

Keep in mind, these charts do not take into account big purchases like cars, boats, airplanes or homebuilding equipment. You can add the sales tax from those items on to your number from the IRS chart.

So if you bought a new car in 2004, add on that sales tax. Or if you put an addition on your house and bought all the materials yourself, as long as you have the receipts, you can also add that sales tax on, says Logan.

Then compare your final sales-tax-paid number to the state and local income taxes you paid. In most instances, you're probably better off putting the higher number on your Schedule A, but there are some circumstances for which planning is necessary.

AMT Issues Again

If you're an alternative minimum tax candidate, your decision may not be so straightforward.

The issue is complicated, but here's a quick synopsis. Depending on where you live, your state and local taxes are not deductible for AMT purposes, says Perlman. So while the deduction lowers your tax bill for federal income tax purposes, it's worthless in AMT land.

On the flipside, you can deduct your sales tax paid when calculating your state tax bill.

So if you already know you're going to be stuck paying AMT, it may make sense to use the sales tax amount, even if it is lower than the state taxes paid. At least the sales tax amount will lower your state tax bill.

This stuff gets thorny, so be sure to talk to a tax pro about it.

Charge Up 2005

Whether you choose to deduct your sales tax paid or your state and local income taxes paid in 2005, you should probably save every receipt anyway, says Lawrence Shoenthal, a senior tax manager with Weiser LLP in New York City. That's because you never know which way will be more beneficial until you actually crunch the numbers.

And if you're planning on making any big purchases, do it before the year is out. This sales tax option is only available through Dec. 31, 2005, and while many tax pros think it will be extended, no one knows for sure.

So go spend some money. And save your receipts!