Sales Tax Deduction

Taxpayers who itemize can now choose between deducting state income tax and deducting sales tax.

Congress eliminated the itemized deduction for sales tax in 1986, but now it's back, at least temporarily, in a modified form. For 2004 and 2005, taxpayers who itemize will be allowed to claim this deduction, but only if they do not claim an itemized deduction for state or local income tax. You can deduct one kind of tax or the other, but not both. (See below for a possible trap in making this choice.)

Itemizers Only

To claim this deduction, you have to itemize. Taxpayers who claim the standard deduction (a majority of taxpayers) don't benefit from this change. However, some taxpayers who previously claimed the standard deduction will find that they come out better with itemized deductions now that this deduction is available.

How It Works

The IRS has made corrections to Publication 600 for Arkansas, California and Virginia. If you live in one of those states and obtained it before 1/5/05 you should get the new version.

Apart from the requirement to choose between deducting sales tax or income tax, the new rule will work the way the old one did, for those old enough to remember it. You have a choice between two different ways to claim the deduction.
    One way is to collect receipts for all your purchases when you pay sales tax, and then add up the sales tax on all those receipts. Most people find that's more work than it's worth, but you're allowed to do this if you think it will provide a better result.
    The other way is to use tables appearing in IRS Publication 600. The table will tell you how much sales tax to deduct based on your income level and the state where you live. You can increase that amount by any sales tax you pay on the purchase of an automobile, aircraft, boat or home (including home building materials).
    Using the IRS table is a lot easier, but you may suspect you're getting cheated when you take this approach. The the tables used back in the 1980s were reasonably generous, so that shouldn't be a concern unless your spending on items subject to sales tax is unusually high for someone with your income level (for example, when you're living off savings). I suspect most people will do just as well or better using the table amount even if they collect all their sales tax receipts.

The deduction is not allowed for sales tax you incur as part of your business. That cost should be deducted (to the extent allowed) as part of your business expenses.

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