Itemized Deductions for State and Local Taxes
Paying the Lowest Taxes and Getting the Biggest Refund
Oct 12, 2009
United States income tax is computed based on a taxpayer’s Taxable Income. In order to arrive at taxable income, individuals reduce Adjusted Gross Income (AGI) by deductions.
One category of deductions is state and local taxes, either income or sales taxes, but not both. A deduction for state and local taxes is only allowed when itemizing deductions. Taxpayers who utilize the Standard Deduction cannot also deduct itemized expenses.
A taxpayer can determine each year whether to itemize or take the Standard Deduction based on their situation each year. They are not locked into an option based on a choice from a prior year.
When to Deduct State and Local Taxes
For cash basis taxpayers, which includes most individuals, taxes are deducted when paid. It does not matter when for which tax year the taxes are paid. For instance, taxes deducted from a pay check in 2009 can be deducted for the 2009 tax return, filed in 2010.
Estimated taxes paid in June 2009 year should be deducted for 2009. A final payment paid in March 2009 for the tax year of 2008 would still be deducted in 2009. A final payment in April 2010 to finalize a 2009 return would go toward the 2010 taxes.
Taxes paid with a credit card can be deducted when charged, not when the credit card bill is paid.
Special Rules for State and Local Taxes
If a taxpayer receives a refund for a prior year’s state or local taxes, it is important to note to which tax year the refund pertains. If the taxpayer itemized deductions on the federal tax return for the year of the refund, then the taxpayer must record the refund as income.
The reasoning behind this is that taxes were paid in the prior year reduced taxable income if the taxpayer itemized. They must be added back in order for taxes to be fully accounted over time. If the standard deduction was used in the prior tax year, the refund would not be counted as income.
The prior year refund is added to the federal return, most states allow for that income to be eliminated on the current year’s state return.
Sales Taxes instead of State and Local Taxes
Since taxpayers can deduct either state and local sales taxes or income taxes, but not both, they should choose the method that gives the largest deduction.
Taxpayers can use the actual sales taxes paid, or a calculation based on income and the state or county of residence. The IRS website offers tables or a calculator to figure the tax. Remember, if actual sales taxes are claimed, they must be documented with receipts, or will be disallowed on audit.
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