How Itemizers Can Calculate Sales Tax Write-Offs

For those of you who’re just joining in, part one explained Form 1040’s Schedule A allows itemizers to deduct state and local income taxes or state and local general sales taxes. They can’t write off both in the same year (line 5a of 2020’s Schedule A for itemized deductions).

Part two discussed breaks on deductions for sales taxes for residents of states with low rates for income taxes and for seniors who live in states that authorize lower rates, exemptions and other kinds of special breaks for retirement income.

Part three explains that itemizers Sydney and Lucie Carton have two options for calculating their write-off for sales taxes. The law allows them to total up the actual taxes on all of their purchases throughout the year, assuming they retained the receipts, or to use the “Optional sales tax tables” that are included in the instructions for Schedule A.

Another break becomes available to the Cartons and other affluent individuals when they shell out sizable payments for state and local general sales taxes on big-ticket purchases of such items as autos, aircraft and boats.

The instructions that accompany Schedule A’s line 5a allow the Cartons to add to the authorized amount from the tables their actual payments on the purchase (or lease) of the following listed big-ticket items.

• Motor vehicles. This category includes cars, motorcycles, motor homes, recreational vehicles, sport utility vehicles, trucks, vans and off-road vehicles;
• Boats or aircraft; and
• Materials to build homes (including mobile and prefabricated homes) or make substantial additions to or major renovations of homes, provided the Cartons pay the taxes directly—that is, they act as their own contractor. There’s no deduction when they hire contractors who pay the taxes on the materials. This holds true even though the taxes are indirectly reflected in what the contractors charge the couple for the materials.

The instructions mandate that the Cartons are able to claim these additional payments only up to the amount that they paid at the general sales tax rate. On the plus side, they’re entitled to the deductions even though car payments, for example, extend well beyond the year in question.

But an adamant IRS requires the Cartons to dispense with the instructions if they want to deduct sales tax payments for items that aren’t mentioned in the tables—for instance, appliances, art works, computers, flat-screen TVs, furniture, furs, gems and yachts. The IRS couldn’t care less how expensive these items are.

The IRS also warns the Cartons not to use the tables and then increase the deduction by adding payments for, say, bling and other luxury items not mentioned in the tables. The U.S. Tax Court upheld this restriction in a dispute that pitted the IRS against Carl Worden.

For the year under review, Carl claimed a total sales tax deduction of $1,498, broken down as follows: $429—the amount authorized by the tables; $540 for sales tax on a car; and $529 for sales taxes on “major purchases” of furniture and other household items.

Unfortunately for Carl, the court imposed a limit on his allowable deduction—either the table amount, plus the tax on the car, or the total amount of actual payments of sales taxes. True, the table guidelines authorize specific additions. Nevertheless, noted the court, “these are the only items that the IRS, as a matter of administrative convenience, has permitted to be added to the optional table amount.”

Translation for accountants and other advisers: Caution clients that the burden is on them to prove the entire amount of the sales tax paid during the year in issue, assuming that—unlike most of us—they had the foresight to retain records that substantiate those payments. Otherwise, the cap on the deduction is the amount in the tables increased only by the specific items mentioned in the tables.

The IRS further advises taxpayers to “keep their actual receipts showing general sales taxes paid to use this method.” Indirect proof, such as annual credit card statements showing purchases for which sales taxes presumably were paid, may prove to be insufficient.

The lesson for accountants and other advisers: Knowing the complexities of the tax code is important, but not enough. Tax planning, along with other aspects of the engagement, is dependent on each client’s particular situation.

Here’s what’s ahead in part four. It discusses the “Optional sales tax tables” that are included in the instructions for Schedule A of Form 1040 and help that’s available at the IRS’s Web site, irs.gov. The site offers an online tool designed to help perplexed taxpayers—or even paid preparers for that matter—calculate the IRS-blessed deduction.