Taxpayers that itemize deductions on Schedule A, (and file Form 1040) can deduct the cost of state income taxes on their federal tax return. The ability to deduct the full cost of these taxes has its obvious advantages. Taxpayers may either claim such a deduction from state and local income taxes or state and local sales taxes, but not both. Basically, to be deductible, the tax must be imposed on a taxpayer and must have been paid during the particular tax year. Taxpayers that elect to deduct state and local general sales taxes, may use either their actual expenses or the optional sales tax tables.
There are four types of deductible nonbusiness taxes:
- State, local, and foreign income taxes
- State, local, and foreign real estate taxes
- State and local personal property taxes, and
- State and local general sales taxes
The above categories include the following eligible expenses that can be deducted for state and local income taxes:
- Withholding for state and local income taxes
- Estimated tax payments paid during the year
- Extension tax payments paid during the year
- Payments made during the year for taxes that arose in a previous year
- Mandatory Contributions to State Benefit Funds
Generally, a deduction or a tax credit may be taken for foreign income taxes imposed by a foreign country or United States possession. Also employees may deduct mandatory contributions to state benefit funds that provide loss of wages protection. Real estate taxes that are deductible consist of any state, local, or foreign taxes on real property levied for the general public welfare. The paid tax must be for a uniform charge against all real property in the jurisdiction at a like rate.
Taxpayers may not deduct the local benefit taxes imposed by many states and counties for improvements to property, such as street, sidewalk, and sewer line assessments. Although these taxes are not deductible, taxpayers may increase the cost basis of their real property by the amount of the assessments. A deduction may be taken for local benefits taxes if they are for maintenance or repair, or interest charges related to those benefits.
If a lender pays your real estate taxes out of an escrow account to the local taxing authority, usually the county, only deduct the amount actually paid from the escrow account during the year. Deductible personal property taxes are those based only on the value of personal property such as cars, boats, or recreational vehicles. The tax must be charged annually, regardless of how many times it is actually collected during the tax year.
Some taxes and fees you cannot deduct on Schedule A include federal income taxes, social security taxes, transfer taxes on the sale of property, homeowner’s association fees, estate and inheritance taxes, and service charges for water, sewer, or trash collection.
Some taxpayers may be subject to a limit on some itemized deductions including nonbusiness taxes. In addition to these limits, there may be a phaseout or reduction of total itemized deductions, based on adjusted gross income.
The deduction for state and local income taxes is an adjustment item when calculating the alternative minimum tax (AMT), meaning that state and local income taxes are deductible when calculating the regular federal income tax, but not deductible when calculating the AMT. Thus, taxpayers with AMT liabilities generally receive little or no benefit from the deduction of state and local income taxes.
The following is just a short list of documents which indicate the amount of state or local taxes paid during a tax year:
- Form W-2 (Wage and Tax Statement);
- Form W-2G (Certain Gambling Winnings);
- Form 1099-G (Certain Government Payments);
- Form 1099-INT (Interest Income);
- Form 1099-DIV (Dividends and Distributions);
- Form 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.);
- Form 1099-MISC (Miscellaneous Income);
- Bank statements with copies of canceled checks for estimated payments and late payments of state tax.
- The portion of the previous year’s state refund applied toward estimated taxes.
If you have a question or concern about a possible deduction relating to state or local taxes, call THE TAX EXPERTS at the Thorgood Law Firm www.thorgoodlaw.com. For a FREE consultation call 212-490-0704.
