Are you wondering what type of taxes you should deduct on your federal income tax return? I recently saw a blog by Ken Berry on accoutningweb.com, and thought I’d share the information with you. Here is what he had to say:
It’s a given that you can deduct state and local taxes on your 2016 federal income tax return if you’re an itemizer. But what kind of taxes?
Normally, the deduction covers state and local income taxes, but you can elect to write off state and local sales taxes instead if it suits your needs. Usually, you should go with the deduction that produces the biggest tax payoff.
The optional deduction for state and local sales taxes, which has expired and been revived several times in the past, was recently extended by the Protecting Americans from Tax Hikes (PATH) Act of 2015. The PATH Act made this election permanent once and for all.
Typically, you’ll still come out ahead if you deduct income taxes, especially if you’re a resident of a high-tax state, like California or New York. The deductible amount includes amounts withheld from your paycheck and quarterly estimated tax payments. For upper-income taxpayers, the figure often reaches into five figures.
However, in some cases the deduction for sales taxes will be preferable if you purchased several high-cost items in 2016. Furthermore, if you live in a state with relatively low income tax rates or one of the seven states with no income tax – Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming – you’ll likely fare far better by deducting state and local sales taxes. There are two ways to do it.
- Deduct the actual amount of sales tax you paid during the year.This requires you to keep tabs on your expenditures that can be backed up by receipts and other documentation if the IRS ever challenges the deduction.
- Take the easy way out and refer to the special IRS table used for this purpose. The table lists flat amounts on a state-by-state basis and reflects your annual income and the size of your family.
The table amount is usually lower than the actual sales taxes you’ve paid for the year, but it’s less of a hassle. Furthermore, you can tack on the tax for several big-ticket items, like cars, boats, and home improvements.
For example, say that you reside in Colorado, earn $200,000 a year, and have a family of four. The IRS table amount for your state is normally $694, but you bought a new SUV in 2016 and paid sales tax of $3,000. As a result, your total sales tax deduction can be as high as $3,694 if you use the table amount.
For the majority of taxpayers, deducting income taxes is the tax-smart approach, but there’s no substitute for crunching the numbers. And it’s good to know that you have this option at your disposal if you want it.
If you are unsure which method is best for you, discuss your situation with your CPA to help determine how you want to file.
