More about Sales Tax

That new car you've been eyeing might suddenly look even more enticing.

Thanks to a law adopted by Congress and signed by President Bush late last month, consumers can deduct federal, state and local sales taxes for the first time since 1986. The law creates an opportunity for some people to go on a year-end shopping spree -- or to postpone one.

But there are some catches, and the new rules almost certainly will heighten taxpayer confusion.

In particular, you must decide whether to deduct sales taxes or state income taxes, because you can't do both.

And if you don't already itemize or list your deductions separately, you will need to do so because the new break applies only to people who itemize.

The Internal Revenue Service is scrambling to unveil a new booklet, Publication 600, that describes the changes in detail. But it isn't slated to appear until mid-December, not leaving much time for year-end tax planning.

In fact, the law change came so late in the year, on Oct. 22, that updates aren't included in Form 1040 booklets that will go out in January, said Bill Brunson, an IRS spokesman in Phoenix.

Also worth noting: The new law creates a mere two-year window for sales taxes, as the deduction can be taken in 2004 and 2005 only.

People who live in states lacking a state income tax, such as Florida, Nevada, Texas and Washington, have the most to gain. But even residents of Arizona and other states with fairly low income-tax rates and lofty sales-tax levies may find the new rule to their liking.

Many taxpayers who previously didn't itemize may now benefit from itemizing, said William Massey, a senior tax analyst at RIA, a research firm in New York.

In general, the new law encourages taxpayers to retain sales-tax receipts. But if you don't have them, you can use standardized amounts from IRS tables that will be included in Publication 600.

Those amounts will vary according to a person's filing status, dependents, adjusted gross income, and state and local sales tax rates, Brunson said.

Even if you rely on the IRS tables, you can boost your deduction with sales taxes you pay on cars, boats and other big-ticket items that the IRS hasn't yet specified.

If you're planning a big-ticket purchase fairly soon, it might pay to do so in the waning weeks of 2004, or it might pay to delay until 2005.

That timing decision partly hinges on whether you think your tax bracket will change between this year and next, whether you plan to itemize in one year but not both, and whether you have several big purchases that can be lumped into one year or the other.

If you're going to make purchases that generate a lot in sales taxes, try to bunch those deductions into one year, said Howell Cheek, managing partner at Scottsdale accounting firm Sigrist, Cheek & Potter.

Revival of the federal sales-tax deduction could cost Arizona and other states money.

There will be a cost to the state, but there's no way to gauge it at this point, said Dan Zemke, a spokesman for the Arizona Department of Revenue. He speculated the effect would be fairly modest.

Arizona residents paid $1,013 on average in state income taxes in 2002, the most recent year for which the department has final data. Excluding people with no tax liability, the average bill was $1,289, Zemke said. About 45 percent of Arizonans itemize.

Because most people don't itemize, some critics wonder if the new break will mainly benefit the rich. On the other hand, sales-tax deductions will phase out for certain higher-income taxpayers subject to the alternative minimum tax.

The sales-tax deduction was revived by the American Jobs Creation Act. The bill also makes various other tax changes, such as extending equipment deductions for small businesses, scaling back deductions on vehicles donated to charity and reducing the write-off for sport utility vehicles used in business.

Tax deductions

Congress and President Bush recently moved to let individuals choose whether to deduct sales taxes or state income taxes on federal returns for 2004 and 2005.

In general, sales-tax deductions will make more sense for people paying high sales taxes and no income taxes, as in Nevada, or relatively low income taxes, as in Arizona. Here are facts that affect the decision:

* The federal standard deduction for joint filers is $9,700 in 2004, rising to $10,000 in 2005. Taxpayers can write off their sales taxes only if they itemize and thus forsake the standard deduction.

* Arizonans pay state income taxes at rates of 2.87 percent to 5.04 percent.

* Arizona levies a 5.6 percent sales tax, and most counties and cities tack on their own charges. Total sales taxes in most areas of Maricopa County range from about 7.7 percent to 8.8 percent.

* The new law allows individuals to deduct local as well as state income taxes, but no Arizona cities or counties levy their own income taxes.

* Arizonans who incurred a state income-tax liability paid $1,289 on average in 2002.

Possible savings

A new law allows consumers to deduct state and local sales taxes instead of state and local income taxes.

To illustrate how this might affect Arizonans, Ellen Campbell, an enrolled-agent tax specialist in Phoenix, devised the following simplified scenario:

Assume a family of four earns $125,000 a year and has a total $30,000 in itemized deductions for mortgage interest, charitable contributions, medical expenses, real estate taxes and vehicle license fees.

That would leave the family owing federal taxes of $14,451 and Arizona taxes of $2,709 for 2004.

But because the law has changed, the family has the option to deduct sales taxes. They calculate they incurred $1,600 in general sales taxes and decide to buy a $25,000 car before year-end, paying an 8 percent tax rate and boosting their total sales tax to $3,600.

By buying the car and deducting $3,600 in total sales taxes vs. $2,675 in Arizona income taxes withheld, they would save $231 in federal taxes and $35 in Arizona taxes, Campbell said.