2009 Tax Strategy VI – Deductable Taxes

This is my sixth posting of a daily tax tip. This is about Tax Deductions

Generally, the following taxes are deductable:
(1) State and local income tax [Includes the California SDI]
(2) Real Property Tax
(3) Personal Property Tax
(4) Foreign Tax Paid
(5) The larger of
(a) State and Local Income Tax paid
(b) Sales tax paid
(6) If 4(b) is not used, sales or excise tax paid on the purchase of a new vehicle

To deduct the above taxes, two general tests must be meet
(1) The tax must be imposed on the Taxpayer (except where local law does not specify on whom the tax is imposed).
(2) The tax must be paid during the year.

In the case of sales tax, either the Taxpayer can deduct the actual amount paid during the year or use an IRS income based schedule. If the Taxpayer decides to deduct actual tax paid, they must have all receipts to support the deduction. Generally, Taxpayers have not kept all of their receipts, so using the IRS table is recommended

For the sales tax on new vehicles, there are additional requirements.
(1) This includes tax on cars and motorcycles
(2) The maximum cost of the vehicle cannot exceed $49,500.

For property taxes, if the Taxpayer does not itemize deductions, an additional amount can be added to the standard deduction, but no more than $500 for single Taxpayers and $1,000 for Married filling Joint Taxpayers.

It is important to understand that under the Tax Benefit Rule, the amount deducted or credited for income tax in an earlier tax year needs to be included in income in the current year. However, if the Taxpayer chooses to deduct sales tax instead of stat income tax and receive a state refund for that year that refund is not 100% taxable. The amount of refund includable in income is limited to the excess of the income tax the taxpayer chose to deduct over the sales tax they did not choose to deduct.

Example 1 – Assume in 2008 the Taxpayer chooses an $11,000 state income tax deduction over a $10,000 sales tax deduction. Since the state income tax deduction is the largest, he chooses to deduct the state income tax. In 2009, he receives a $2,500 state income tax refund. According to the Tax Benefit Rule by deducting the $11,000 state income tax was only $1,000 more than, if the $10,000 sales tax deduction was used. Thus, only $1,000 of the $2,500 refund is taxable.

Example 2 - If in the above example the facts are reversed, the Taxpayer chooses an $11,000 sales tax deduction over a $10,000 state income tax deduction. In this case, none of the income tax refund is deductable