For those of you who’re just joining in, part one explained that 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).
Which one should they deduct on their 2020 taxes? The choice isn’t always clear-cut.
Part two explains why sales-tax deductions can be more advantageous for residents of states with low rates for income taxes. Ditto for seniors who live in states that authorize lower rates, exemptions and other kinds of special breaks for retirement income
Possibilities for seniors include: their Social Security benefits; and their withdrawals from such tax-deferred retirement plans as traditional IRAs, 40l(k)s, and 403(b)s, and those that are designed for self-employed persons. When tax time rolls around, it pays for them to deduct their state and local sales taxes instead of their state and local income taxes.
Let’s focus on New York, a state that grants special breaks for retirement income. New York doesn’t tax Social Security benefits.
Nor does New York tax these kinds of income: interest on U.S. government bonds; pensions paid by New York and local governments and the federal government; and the first $20,000 of distributions from pensions and distributions from traditional IRAs, 401(k)s, 403(b)s and other kinds of tax-deferred retirement accounts. (Lines 26-29 on the 2020 version of IT-201, New York State Resident Income Tax Return.)
Consequently, many New York retirees who pay relatively little or nothing in state or local income taxes are able to deduct more for state and local general sales taxes. This benefit is similarly available to retirees in some other states.
Note that New York sets strict rules for married taxpayers. Suppose Sydney and Lucie Carton file a joint IT-201. While both qualify for the exclusion of as much as $20,000 for pensions and distributions from traditional IRAs and each can exclude up to $20,000, one can’t claim any unused part of the other’s exclusion.
For instance, the Cartons include pensions of $45,000 on their 1040 form. Lucie’s is $30,000, and Sydney’s is $15,000. On IT-201, Lucy can exclude $20,000, and Sidney can exclude $15,000, for a total exclusion of $35,000.
Another potential 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. First and foremost, insists the IRS, they must be diligent about saving records that show their actual expenditures.
Individuals like the Cartons living in states with both income taxes and sales taxes may find that their big-ticket purchases make deductions for sales taxes more attractive than deductions for income taxes. For individuals who live in states without income taxes, the sales tax deduction becomes even more valuable when those items are included in the mix.
More on Sydney and Lucie. When they decide to take a Schedule A deduction for sales taxes, they then have two options for calculating their write-off. One is to total up the actual taxes on all of their purchases throughout the year. This assumes that they retained the receipts. The other is to use the “Optional sales tax tables” that are included in the instructions for Schedule A.
Here’s what’s ahead in part three of this five-part series. It explains how the Cartons can add to the amount authorized by the tables their actual payments on the purchase (or lease) of certain big-ticket items like cars, aircraft and boats.
Part four discusses help available at the IRS’s Web site, irs.gov. It offers an online tool designed to help perplexed taxpayers like the Cartons —or even paid preparers for that matter—calculate the IRS-blessed deduction.
