Federal, state, and local governments need money to fund various programs and services related to public safety, education, parks, recreation, and infrastructure. Part of this funding may come from charging consumption taxes.
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What is a consumption tax?
A consumption tax is essentially a tax charged when someone spends money on goods or services. While a business or government may collect these taxes, they're typically passed onto consumers. They may be directly tacked onto the cost of goods or services at the register or indirectly built into the product or service's price.
Consumption taxes can take several forms:
- Sales tax: A flat-rate tax on all sales from businesses to consumers. Typically, sellers collect sales tax from the consumer at the point of purchase. As of January 1, 2021, 45 states and the District of Columbia collect statewide sales taxes, and many localities do as well.
- Value-added tax: This is like a sales tax, but it's collected in small pieces at each stage of the production process — from labor and raw materials to the final product — rather than entirely at the final sale. The U.S. currently does not have a federal value-added tax (VAT) on goods and services.
- Excise tax: Excise taxes are paid on the purchase of specific goods and services. Examples include gasoline, alcohol, tobacco, indoor tanning services, sports wagering, or highway usage by trucks. Governments impose excise taxes on the supplier or producer, who then passes the cost along to consumers by including it in the product price.
- Import taxes and tariffs: A government imposes import taxes (or import duties) and tariffs on goods from other countries. It's typically passed on to the consumer. This increased price on imported goods is meant to encourage buyers to support domestic manufacturers. The tariff refers to the tax rate, while the duty refers to the actual amount paid. For example, if you import $100,000 worth of product to the U.S. and a tariff of 4.5% applies, the duties would be $4,500.
How do consumption taxes affect your federal income tax return
You may be wondering whether you can deduct consumption taxes on your federal income tax return. It all depends on whether you're filing an individual or business return.
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Individuals can deduct sales taxes as an itemized deduction
If you itemize, you can either deduct your state and local income taxes OR your state and local sales taxes, whichever results in a bigger tax benefit.
You can calculate your sales tax deduction by either:
- Saving receipts throughout the year and deducting your actual sales tax expenses. This could be beneficial in years when you paid sales tax on big-ticket items such as electronics or home furnishings.
- Estimating your sales tax deduction using the optional sales tax tables. The tables base your sales tax deduction on the state in which you live, your family size, and income level. (TurboTax will take care of calculating the deduction for you based on the IRS tables.)
- In addition to the amounts provided in the table, you can deduct actual expenses paid for specific items, such as buying a new vehicle, a motor home, home building or renovation materials, a boat, or an aircraft.
Just keep in mind that IRS rules cap the state and local tax deduction at $10,000 per return (or $5,000 for married couples filing separately). If your total state and local sales tax and property taxes are greater than $10,000, you lose any excess deduction.
Individuals can't deduct other types of consumption taxes, such as excise taxes, if paid on personal-use items.
Businesses can deduct consumption taxes as a business expense
Businesses have a lot more options when it comes to deducting consumption taxes. In general, any taxes incurred in operating your business (other than federal income taxes) are deductible business expenses. Here's what this could include:
- Sales tax paid on items you buy for your business's day-to-day operations is deductible. Sales tax paid on things like office supplies are deductible as part of the item's cost; it's not deducted separately. Sales tax paid on capital assets, such as a business vehicle, are added to the vehicle's cost basis.
- As of 2020, over 160 countries have a value-added tax. If you do business in one of these countries, you can deduct the value-added tax you pay on purchases as a cost of goods sold.
- Excise taxes paid on ordinary and necessary business expenses are deductible. If you operate a business that is required to collect an excise tax from customers, you need to file Form 720, Quarterly Federal Excise Tax Return to report the tax to the IRS.
- If you pay an excise tax when you buy items for your business' day-to-day operations, they're either deductible as part of the item's cost or added to the item's cost basis. In some cases, excise tax for business can be claimed as a credit on an individual’s tax return, including off-highway business use fuel tax with Form 4136.
- If your business pays import taxes and tariffs on raw materials, goods for resale, or products used in your day-to-day operations, the expense is deductible. Like sales taxes and excise taxes, duties and tariffs may be deductible as part of the cost of the item, as a cost of goods sold or as part of the item's basis, depending on how the item is used in your business.
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