According to the U.S. Treasury Inspector General for Tax Administration, over 2 million taxpayers fail to take a state sales tax deduction on their federal income taxes. This works out to nearly $4 billion in missed deductions each year.
In this article, we're going to explain how taxpayers can take advantage of the state sales tax deduction when filing their federal income taxes. We'll explain what form you need to file, as well as the eligibility rules. We're also going to provide several examples to illustrate the potential impact of this deduction on your federal income tax liability.
Sales Taxes Deductions
If you're living in a state that does not charge a state income tax, then you should carefully consider whether you're eligible to deduct the sales tax that you pay each year to other jurisdictions. As mentioned in our article on state income tax rates, there are currently seven states that do not collect any state income taxes at all: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. In addition, New Hampshire and Tennessee only collect income taxes on dividends and interest income.
On the downside, the states of Alaska, Delaware, Montana, New Hampshire and Oregon do not have any state sales tax. We mention these two combinations because taxpayers are eligible to take a deduction for state and local sales tax or state and local income tax - but not both.
Schedule A - Itemized Deductions
In fact, to be eligible to take this deduction, you must also itemize your deductions using the tax form Schedule A. It is here where the instructions on taking this deduction can be found. Specifically, the instructions for Line 5 state:
You can elect to deduct state and local general sales taxes instead of state and local income taxes. You cannot deduct both.
So to summarize what we've talked about up to this point, you can take the sales tax deduction:
If you live in a state that has a sales tax or you can prove you've made purchases involving significant sales tax charges.
You believe that the sales tax deduction will be greater than any state and local income taxes you pay.
You elect to itemize your deductions, and do not take the standard deduction when you file your federal income taxes.
Actual Sales Tax Versus Calculated Values
Generally, there are two ways to calculate your sales tax deduction. The first involves deducting actual expenses. The second method uses sales tax tables.
If you're going to calculate your sales tax deduction using actual expenses, then you need to make sure you have receipts showing the sales tax paid. This method would be preferred if you made a large purchase such as a car, boat, or motor home.
If you use the sales tax tables found in the instructions to Schedule A, then you'll notice there are only three variables that determine the size of the deduction:
Sales Tax Rate - the higher the sales tax rate in your state, the larger the deduction you can take on your taxes.
Exemptions - the more exemptions you can claim on your income taxes, the larger the deduction you can take on your taxes.
Income - individuals with higher levels of income are entitled to larger sales tax deductions.
Sales Tax Examples
The following examples should help you get a better sense of the possible deductions that can be taken:
Our first example involves a family of five with household income of $75,000 living in Jacksonville, Florida. In 2010, the state sales tax rate in Florida was 6.00% and local sales tax is 1.00%. This combination allows for a tax deduction of $1,150.
Our second example involves a family of five with household income in excess of $200,000 living in Jacksonville, Florida. The higher level of income allows this taxpayer to deduct $2,518 from their taxes.
Our third example involves a family consisting of one individual with household income in excess of $200,000 living in Jacksonville, Florida. The lower number of exemptions allows this taxpayer to deduct $1,690 from their taxes.
Our fourth example involves a family of five with household income of $75,000 living in Denver, Colorado. In 2010, the state sales tax rate in Colorado was 2.90% and local sales tax is 1.95%. This combination allows for a tax deduction of $765.
Tax Deduction Calculator
As mentioned earlier, you can use sales tax tables appearing in the instructions to tax Schedule A to calculate the sales tax deduction you're entitled too (but is often missed). Alternatively, the IRS publishes a sales tax calculator that can be found here. In fact, all of the deduction amounts appearing in the examples in this publication were determined using this online tool.
Additional Resources
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