Taxes
Taxpayers are allowed an itemized deduction for certain state, local, and foreign taxes paid during the year. The purpose of the deduction is to relieve the burden of multiple taxation of the same income. However, the tax law distinguishes between a “tax” and a “fee.” A tax is imposed by a government to raise revenue for general public purposes, and a fee is a charge with a direct benefit to the person paying the fee. Taxes are generally deductible; fees are not deductible. For example, postage, fishing licenses, and dog tags are not deductible as taxes.
If a taxpayer itemizes his or her deductions on Schedule A, the following taxes are deductible for 2008:
Income taxes (state, local, and foreign)
Real property taxesreal property taxTax imposed (usually by local government) on real estate; based on value of property. (state, local, and foreign)
Sales taxes (option in lieu of state and local income tax)
Personal property taxespersonal property taxTax imposed (usually by local government) on personal property (e.g., automobile, boat, recreational vehicle); portion of tax based on value is deductible. (state and local)
The following taxes are not deductible:
Federal income taxes
Employee portion of Social Security taxes and Medicare
Estate, inheritance, and gift taxes (except in unusual situations not discussed here)
Foreign taxes if the taxpayer elects a foreign tax credit
Gasoline taxes
Excise taxes
Taxes paid (e.g., payroll taxes, personal property taxes, etc.) in connection with a trade or business or any activity for the production of income are deductible for AGI by the taxpayer on Schedule C (self-employment earnings), E (rents and royalties), or F (farm income), instead of Schedule A. Chapter 7, Income: Self-Employment, Rental, Partnership, and Other will cover income and expenses from trade or business activities.
For taxpayers electing to deduct state and local income taxes paid during a taxable year, the amount of the deduction is the total amount of state and local taxes withheld from wages plus any amounts actually paid during the year, even if the tax payments are for a prior year’s tax liability. If the taxpayer receives a refund of taxes deducted in a previous year, the refund must generally be included in gross income in the year the refund is received. Taxes that did not provide any tax benefit (reduction in taxes) in the year paid are not required to be included in income in the year received as a refund. For example, a taxpayer claiming the standard deduction in the year taxes are paid does not receive a tax benefit for the payment of taxes and is not required to take a tax refund received the following year into income.
Example
For tax year 2008, Meg elects to take state income taxes rather than state sales taxes as an itemized deduction. Meg has $2,300 of state income taxes withheld from her wages during the current year. In April of the current year, she paid an additional $600 on her prior year’s state income tax return. Her state income tax liability for the current year is $2,650, resulting in a tax due of $350 ($2,650 – $2,300). Meg’s deduction for state income taxes is $2,900 ($2,300 + 600). The $350 amount paid with her tax return will be reported as deduction on the 2009 tax return.
Taxpayers electing to deduct sales taxes in 2008 calculate the deduction by using either (a) actual sales taxes paid or (b) sales taxes from IRS tables that also allow for adding the actual amount of sales tax for motor vehicles, boats, airplanes, and building materials (not appliances or furnishings) for building or improving a residence. Taxpayers choosing to deduct actual sales taxes paid will be required to keep extensive records to support the amount of the deduction claimed including receipts for every item purchased during the year subject to sales tax. IRS Publication 600 State and Local General Sales Taxes provides more information and the tables for sales tax deductions by state.
Taxes that are levied on state, local, or foreign real property for the general public welfare are deductible. However, special assessments charged to provide local benefit to property owners are not deductible; these amounts increase the basis of the taxpayer’s property. Also, service fees, such as garbage fees and homeowner association fees, are not deductible as property taxes.
If real estate is sold during the year, the taxes must be divided between the buyer and seller, and the division must be made according to the number of days in the year that each taxpayer held the property. Generally, the escrow company or closing agent handling the sale of the property will make the allocation of taxes for the buyer and the seller, and the result will be reflected in the settlement charges on the transfer of the title. These amounts are itemized on closing statements for the sale, which are provided to the buyer and the seller.
Example
Mike purchased a new residence from Nancy on July 28, 2008 (a leap year). Mike’s closing statement shows that he receives a credit for $2,158.52 ($3780 × 209/366) in taxes that he will pay later in the year for the seller. Assuming that Mike pays $3,780 in total taxes on the property later in 2008, his property tax deduction for 200X would be $1,621.48 ($3780 – $2,158.52). Nancy, the seller, would be allowed a deduction for $2158.52 plus any other taxes she paid prior to selling the property.
To be deductible as an itemized deduction, property taxes must be levied based on the value of the property. Taxes of a fixed amount, or those calculated on a basis other than value, are not deductible. For example, automobile fees that are calculated on the basis of the automobile’s weight are not deductible.
Example
Oksana lives in a state that charges $30 per year plus 2.5% of the value of the automobile for vehicle registration. If Oksana pays $480 [$30 + (2.5% × $18,000)] for her automobile registration, she may deduct $450, the amount that is based on the value of the automobile.
Go to Publication 17 and read Chapter 22: Taxes.
Questions and Problems
Which of the following taxes may be deducted as itemized deductions for 2008?
State gasoline taxes
Fishing license fee
Federal income taxes
Social Security taxes
Local income taxes
Deb had $3,100 in state income taxes withheld from her paychecks during 2008. In April of 2008, Deb paid $300 to the state when she filed her 2007 state tax return. Deb’s total tax liability on her state tax return for 2008 is $2,850. How much should Deb deduct as an itemized deduction for state income taxes on her 2008 federal income tax return?
$3,400
$3,150
$3,100
$2,850
None of the above
Joel’s employer withheld $1,950 in state income taxes from his wages. Joel obtained a refund of $400 this year for overpayment of state income taxes last year when he claimed state income taxes as an itemized deduction on his return. His liability for this year’s state income tax is $1,700. What amount can Joel deduct for state income taxes on his federal tax return assuming he elects to deduct state income taxes for 2008? $__________
Josh sells his home to Karl on March 2, 2008. Karl pays the property taxes covering the full calendar year in October, which amount to $3,400. How much may Josh and Karl each deduct for property taxes in 2008?
Josh can deduct $__________. Karl can deduct $__________.
Kathy is a single taxpayer living in Colorado with AGI for the 2008 tax year of $48,050. Kathy’s employer withheld $4,300 in state income tax from her salary. In April of 2008 she pays $450 in additional state taxes for her prior year’s tax return. The real estate taxes on her home are $1,900 for 2008, and her personal property taxes amount to $480. Also, she paid $125 for state gasoline taxes for the year. Complete the Taxes You Paid of Schedule A for Kathy. The total amount of taxes she may deduct is $__________.
