How to Deduct Sales Tax

Residents of states that don't levy state income taxes will benefit from a law allowing taxpayers to deduct state sales tax on their federal income tax returns. Residents of other states can also take the deduction, but there is no double-dipping allowed. You cannot deduct both sales tax and state income tax. You must also itemize your deductions. You will receive no benefit from this new tax break if you take the standard deduction.

Difficulty: Moderately Easy

Instructions

Things You'll Need:

• IRS Publication 600
• Schedule A
• Register receipts

Deduct Sales Tax

1. Make a choice. Residents of states with income taxes must decide whether to deduct state sales tax or state income tax.

2. Determine whether your state has a higher income tax or sales tax rate. Residents of states with a higher state sales tax may save more money by choosing to take the sales tax deduction.

3. Save your register receipts. You are allowed to deduct the actual amount of sales tax you paid. You must save your receipts, calculate the sales tax at the end of the year and store the receipts in a safe place in case you have to prove to the IRS how you came up with your deduction.

4. Use the amounted listed in the sales tax table for your state in IRS Publication 600. The tables are based on adjusted gross income, but you are allowed to add nontaxable income such as social security, tax-exempt interest and workers' compensation to that amount.

5. Use the hybrid option to determine your sales tax deduction. Taxpayers are allowed to add sales tax paid on homes (including building materials), automobiles, watercraft and aircraft to the amount found in the sales tax table.

6. Complete IRS Schedule A. You must itemize your deductions to take advantage of this tax break. Once you have figured your sales tax deduction, list it on line 5 and put "ST" next to it to indicate that you are claiming sales tax and not state income tax.

Tips & Warnings

• Deduct the sales tax you pay as part of your business on IRS Schedule C. You cannot deduct it as an itemized deduction.
• Don't forget to check for the alternative minimum tax. Taxes paid are a preference item. Deducting more taxes may make you liable for the AMT.
• The law allowing a deduction for state sales tax is set to expire at the end of the 2007 tax year. It is up to Congress to re-legislate it. Check with your tax adviser before taking this deduction in future tax years.