Year-End Planning for Deducting Taxes Paid

Case Study

16 Nov Year-End Planning for Deducting Taxes Paid

A new law makes the sales tax deduction permanent, so keep in mind that you deduct sales tax instead of state and any local income tax. You cannot deduct both sales and income taxes.

The new provision obviously will benefit taxpayers who live in Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming – none of which has state income tax. If you live in such a state and it pays for you to itemize, you can deduct sales tax you paid.

Residents of other states who itemize their deductions must decide whether to deduct sales or income tax.

Example 1: As the year-end nears, Tara Lane calculates how much state income tax she will wind up paying in 2016. That includes amounts withheld from her income and any estimated tax payments. Suppose the total will be $5,000. If Tara will have paid more than $5,000 in sales tax for the year, she should deduct sales tax on her federal return. Otherwise, she should take her $5,000 state income tax deduction.

To calculate her sales tax payments, Tara can check her receipts for the year. Lacking complete records, Tara can use the Optional Sales Tax Tables, provided by the IRS in the instructions to Schedule A. Still another option is to use the IRS Sales Tax Deduction Calculator, available here, which calculates the amount of the deduction based on the tables for you.

The higher your income (including tax-exempt interest income and certain other inflows), the more sales tax you will be assumed to have paid using the tables. Regardless of your income, however, you add the amount of tax you paid for motor vehicles (leased or purchased), aircraft, boats, residences, or home building materials to the amount from the IRS tables to determine your total allowable sales tax deduction. If all the allowable sales tax deduction amount exceeds the income tax deduction amount, deduct the sales tax rather than the income tax.

That is where year-end planning for sales tax can come in. Buy big-ticket items before year-end if the tax on those items will be deductible. If a deduction is unlikely, you might decide to postpone the purchase until 2017.

Beyond sales tax

If you decide to deduct state and local income tax payments rather than sales tax, you might choose to accelerate estimated state and local income tax payments due in early 2017 to late 2016, increasing the deductible amount for this year. Similarly, you may be able to move scheduled property tax payments from 2017 to 2016 for an earlier deduction. Both of those tactics, though, may raise your tax bill if you will owe the alternative minimum tax (AMT). Our office can let you know how the AMT would affect prepaying state or local taxes.

Trusted Advice: Local Benefits Tax

  • Many states and counties impose local benefit taxes for improvements to property.
  • These taxes might be assessments for streets, sidewalks, and sewer lines.
  • You cannot deduct these taxes. However, you can increase the cost basis of your property by the amount of the assessment, which may result in a lower tax on an eventual sale of your property.
  • Local benefits taxes are deductible if they are for maintenance or repair, or interest charges related to those benefits.
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