How the new sales tax deduction works

If a taxpayer elects to deduct their state and local sales and use tax, they can chose to either deduct their actual amounts or deduct a standard amount, as determined from a table that is currently being developed by the Internal Revenue Service (IRS) for this purpose. Additionally the taxpayer may add to the table number any amount of general sales tax paid in the purchase of a motor vehicle, boat, or other large item to be defined by the IRS.

Taxpayers, along with their tax preparer, need to evaluate which option will provide the greatest tax advantage, said Steber. Those taxpayers choosing to deduct actual sales and use tax expenses will need to keep their receipts to support the amount of their deduction or opt to use to IRS standard amount table. In any event, always save the receipt for the large item purchases such as a car or boat

Here's a look at the possible savings to an average taxpayer this coming tax season:

Joe Smith is single and lives alone. The state in which Joe resides does not tax state income but it does have a sales tax. Joe earns $40,000 during 2004 and has the following expenses: mortgage interest of $3,000, real estate taxes of $1,500, personal property taxes of $180, and $2,440 for state and local sales tax paid on a car and furniture purchased during 2004. Before AJCA, the total amount Joe could deduct as an itemized deduction ($4,680 = $3,000 + $1,500 + $180) was below the standard deduction for taxpayers filing as Single ($4,850).

.
Under AJCA, Joe can now deduct the state and local sales tax of $2,440. Now
Joe's tax liability for 2004 is: .TABLE                                    
       Income                                          $40,000             
       Itemized Deduction                               $7,120             
       Personal Exemption                               $3,100             
       Taxable Income                                  $29,780             
       Tax on Taxable Income                            $4,181             
       This is a tax savings of                           $575             
.

(Note: If Joe had not kept receipts supporting this deduction, he could have used the amounts provided by the IRS table. Additionally Joe could use a combination of the table and sales tax from the car purchase to compute his tax deduction, picking the best of the choices.)

Now let's take a look at some possible considerations:

Let's assume Joe is planning to get married in 2005 but expects to have similar income and expenses. If Joe waits until 2005 to purchase the car and furniture, Joe would have lost the benefit of the sales tax deduction. This is because the standard deduction ($4,850 as Single in 2004 and $10,000 as Married Filing Jointly in 2005) would have been greater than itemized deductions in both years ($4,680 in 2004 and $7,120 in 2005).

On the other hand, if Joe expects to be in a higher tax bracket in 2005, because of the additional spousal income, and expects to have enough additional combined expenses to be able to itemize deductions in 2005, it may be more advantageous for Joe to purchase the car and the furniture in 2005.

As we head into the holiday season, when high-ticket item purchasing increases in many families, timing a purchase to a few weeks early or later might make a significant difference, said Steber. This new provision just might spur some end of year spending to take advantage of this tax benefit on one's 2004 tax return.