New Math for Tax Deductions
You charge away on your credit card to rack up frequent flier miles, only to find out youcan'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 andcharitable contributions on
Schedule A -- Itemized Deductions
. You also get to deduct anystate 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 congressmenand senators in states without state income tax, you have a choice. You can deduct either yourstate 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, wherethere 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, yoursales 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 inAlaska, there is no state sales tax either, says Jackie Perlman, a senior tax research analyst atH&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 exemptpension income from state taxes, says William E. Massey, a senior tax analyst at RIA, a Thomsonbusiness providing tax information and software to tax professionals. So if they don't pay statetax on pension income, their state tax bill might be fairly low. But if they're spending money intheir 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 andstocked it with equipment.
Since the tax law was passed retroactively, the IRS created
Publication 600 -- Optional State Sales Tax Tables
to help. These tablestake 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 yourhouse and bought all the materials yourself, as long as you have the receipts, you can also add thatsales 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, yourstate and local taxes are not deductible for AMT purposes, says Perlman. So while the deductionlowers 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 salestax amount, even if it is lower than the state taxes paid. At least the sales tax amount will loweryour 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 in2005, you should probably save every receipt anyway, says Lawrence Shoenthal, a senior tax managerwith Weiser LLP in New York City. That's because you never know which way will be more beneficial untilyou 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, andwhile many tax pros think it will be extended, no one knows for sure.
So go spend some money. And save your receipts!
Tracy Byrnes is an award-winning writer specializing in tax and accounting issues. As a freelancer, she has written columns for wsj.com and the New York Post and her work has appeared in SmartMoney and on CBS MarketWatch. Prior to freelancing, she spent four years as a senior writer for TheStreet.com. Before that, she was an accountant with Ernst & Young. She has a B.A. in English and economics from Lehigh University and an M.B.A. in accounting from Rutgers University.