Sunday, February 17, 2008

Did you buy a lot of stuff?

It's tax season, and I thought I'd share some useful information I found regarding tax deductions. If you find talk of taxes boring, and typically pay someone to do your taxes for you, skip to the very last sentence in today's post. For those who do their own taxes and those who find talk of tax deductions interesting, read on. . . .

Prior to 2004, when filing federal income taxes, taxpayers were allowed to deduct from their income the state and local income tax they paid. This was great for those, like me, living in states that collect an income tax. However, it was a bit annoying to people living in states with no income tax, such as Florida and Nevada. In 2004 the government passed the American Jobs Creation Act which, among other things allowed tax payers to deduct from their income the state and local sales tax they paid (see bullet point #4 at this link). While this law was due to expire after 2005, it was extended for one year in 2006 and then extended again for one year in 2007. If it is not extended again this year, then this will be the last year you will be able to make use of the deduction.

There are a few "catches" of course. For instance, you can deduct either the income tax or the sales tax, but not both. Additionally the deduction is only available if you itemize your deductions, not if you take the standard deduction.

If you live in a state that has no sales tax, such as Oregon and Delaware, you'll generally be better off deducting the state income tax you paid. If you live in a state with no income tax, you'll generally be better off deducting the sales tax you paid. Those are obvious, and the people who live on those states are probably already aware of this. On the other hand if, like me, you live in a state with both an income tax and a sales tax, it gets a bit more confusing. The only way to be sure is to figure out your tax burden both ways and see which come out better.

So if you live in a state with both a sales tax and an income tax and you kept every receipt for every purchase you made in 2007, go ahead and add up the sales tax amounts on all those receipts. Bah. Like I'm going to remember to ask for a receipt for every purchase I make for an entire year. Even if I did, there is no way I'm going to be able to keep track of them all. The hassle of trying to find the sales tax on each receipt and add it all up? No way. The odds of me adding it all up without making a single mistake? About the same as the odds that gravity will invert and we'll all start falling up.

But wait, don't give up yet. Those ingenious lawmakers seemed to have realized that was too much too ask. So, they offer a way to estimate your sales tax for the year. So now, if you itemize your deductions, you have a choice of keeping all your receipts and taking the deduction for the actual sales tax you paid or tossing your receipts and taking an estimated sales tax deduction. The IRS provides instructions on how to calculate this estimate, and they also provide a calculator online to save you from having to know how to do math. Great!

Most of the time, where I live, the estimated sales tax is less than the state income tax. This has the unfortunate effect of creating a habit of deducting the state income tax. This brings me to the reason I'm writing this public service announcement. One common reason you might come out ahead deducting the estimated sales tax is the purchase of a transportation vehicle. This is because, if you choose to use the estimated sales tax, the law allows you to additionally deduct the sales tax on the purchase of any cars, boats, airplanes, or other motor vehicles as well as any sales tax on the purchase of a home or home building materials.

I found this information to be quite useful, and I suspect that others will as well. If you bought a motor vehicle, a home, or home building materials in 2007, I'd definitely recommend taking the time to calculate the sales tax deduction using the estimated sales tax plus the vehicle general sales tax to see if it reduces your tax burden. If you made several large purchases and still have the receipts, you might want to give serious consideration to finding those receipts and adding up the sales tax. If you typically pay someone to file your taxes for you, and you made several large purchases or you purchased a home, a motor vehicle, or home building materials, bring those receipts with and mention to the tax preparer that you brought the receipts in case your state sales tax deduction comes out higher than state your income tax.

1 comment:

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