What is the sales tax deduction? How much sales tax can I deduct?
Savvy business folk take advantage of tax deductions to lessen their tax burden, and there are certainly a slew of tax deductions out there for the taking. But not all tax deductions apply to every business scenario, and some deductions may not be what they seem. The sales tax deduction is a case in point.
To help you determine whether and to what extent you can benefit from the state and local general sales tax deduction, this post will answer the following questions:
- What is a sales tax deduction?
- How does the sales tax deduction work?
- What is the standard deduction?
- Can businesses claim the sales tax deduction?
- Are there other types of deductions?
- What’s the difference between a deduction and an exemption?
- What is a sales tax exclusion?
- Should I deduct sales tax?
- Which deductions should I take?
What is a sales tax deduction?
A deduction is something that is or may be subtracted. A sales tax deduction is an amount of sales tax subtracted from a tax bill.
“Sales tax deduction” typically refers to the state and local tax (SALT) deduction offered by the federal government and administered by the IRS. United States taxpayers are entitled to deduct some of the state and local sales and use taxes or state and local income taxes from their taxable income, thereby lowering the amount of federal income taxes they owe.
Is there a state sales tax deduction?
States also offer sales tax deductions, though not in the same way as the federal government. We’ll cover state sales tax deductions in more depth below.
How does the sales tax deduction work?
U.S. taxpayers can lower their individual federal income tax bill by claiming the state and local tax deduction offered by the federal government. The deduction for state and local income, property, and sales taxes for an individual is currently capped at $10,000 ($5,000 if married and filing separately) due to the 2017 Tax Cuts and Jobs Act (TCJA). Prior to the TCJA, there was no limit on the state and local tax deduction.
Taxpayers can deduct property tax and state and local income taxes or state and local general sales taxes, but not state income tax and sales tax.
For example, if you paid $7,000 in state and local sales taxes in 2022 and also $7,000 in state and local income taxes in 2022, you could claim a $7,000 sales tax deduction or a $7,000 income tax deduction. Either would lower your 2022 taxable income, for federal income tax purposes, by $7,000. However, you couldn’t combine the sales tax and state and local income tax deduction to claim a $14,000 SALT deduction.
At which tax rate should you deduct?
Typically, you can only deduct state and local general sales and use taxes paid at the general sales tax rate, but there are some exceptions to that rule. If your state taxes food at a reduced rate, as Alabama will do starting September 1, 2023, you’d be entitled to deduct the general sales tax rate rather than the reduced rate for all your purchases of food.
You usually can’t deduct any tax paid at a higher rate than the general rate; in such cases, you’re only permitted to deduct the amount of tax you would have paid at the general sales tax rate. An example of a higher-than-normal rate is Connecticut’s 7.75% luxury tax on certain apparel and accessories priced more than $1,000, which is greater than the state’s 6.35% general sales tax rate.
How do you calculate the sales tax deduction?
There are basically two ways to calculate how much state and local sales tax you can deduct for individual income tax purposes:
- Itemize your sales tax expenses on the Schedule A
- Estimate the tax paid using the IRS optional sales tax tables (see the instructions for Line 18) and/or the IRS sales tax deduction calculator
It may make sense to use both methods, estimating most sales and use taxes paid but listing large purchases like motor vehicles on the itemized deductions. The IRS allows this.
Whether you itemize some or all expenses, if you claim the sales tax deduction, be sure to keep receipts for all purchases for proof of tax paid.
There’s also a third option: If you don’t want to itemize or estimate the sales tax paid, you can take the standard deduction offered by the federal government. The IRS typically recommends you choose whichever option will give you the greatest tax savings.
What is the standard deduction?
The standard deduction for individual income tax isn’t tied to the state and local sales tax, income tax, or property taxes you paid. It’s based on your filing status, and the allowable deduction usually changes each year.
Standard deduction amounts for tax year 2022, which were due April 2023, are:
- $12,950 for a single person or married filing separately
- $19,400 for a head of household
- $25,900 for a married couple filing jointly
Standard deduction amounts for tax year 2023, due April 2024, are:
- $13,850 for a single person or married filing separately
- $27,700 for a head of household
- $20,800 for a married couple filing jointly
Can everyone take the standard deduction?
Many taxpayers opt to take the standard deduction because it’s more generous than the state and local tax deduction, which is currently capped at $10,000. That said, taking the standard deduction may prohibit taxpayers from benefitting from certain other tax breaks. If you want to deduct your mortgage interest, you’ll need to itemize deductions.
Furthermore, not everyone is eligible for the standard deduction. For instance, you can’t claim the standard deduction if you’re a married individual filing as married filing separately and your spouse itemizes deductions. Estates or trusts, common trust funds, or partnerships also aren’t eligible.
Consult with a trusted tax advisor if you’re not sure which route would be best for you.
Can businesses claim the sales tax deduction?
Businesses can deduct sales tax on eligible business expenses.
“Any sales tax you pay on a service for your business, or on the purchase or use of property in your business is treated as part of the cost of the service or property,” explains the IRS. “If the service or the cost or use of the property is a deductible business expense, you can deduct the tax as part of that service or cost. If the property is merchandise bought for resale, the sales tax is part of the cost of the merchandise. If the property is depreciable, add the sales tax to the basis for depreciation.”
On the other hand, you cannot deduct state and local sales taxes imposed on a buyer that you’re required to collect and remit to your state or local tax authorities. Furthermore, such taxes should be excluded from your gross receipts or sales.
Does the $10,000 cap apply to businesses?
There’s no cap on SALT deductions for C corporations, which pay taxes at the entity level, but the $10,000 SALT limit applies to business owners who report their business earnings as pass-through income.
However, approximately 30 states have passed laws allowing pass-through businesses to pay taxes at the entity level (like C corporations) rather than on the individual income tax returns of the owners or shareholders. If a pass-through entity chooses this option for a given tax year, all owners or shareholders are bound by it.
Are there other types of deductions?
The SALT deduction offered by the federal government isn’t the only sales tax deduction available to businesses. States generally allow a variety of tax deductions as well.
“In the sales tax world, the word ‘deduction’ is a return-specific word,” explains Scott Peterson, VP of Government Relations at Avalara. “No one has a deduction unless they’re deducting something from a tax return. With respect to sales tax, ‘tax deduction’ means nothing outside of a tax return.”
Businesses typically deduct exempt transactions: sales to exempt entities or sales of exempt products or services.
For example, Washington state offers a retail sales tax deduction for exempt food sales, feminine hygiene products, and trade-in allowances. It also offers deductions for artistic and cultural activities, bad debts, and radioactive waste disposal fees. You can learn a lot about a state from its list of deductions.
Deductions work a little differently in Arizona, Hawaii, and New Mexico, because these states don’t have a traditional sales tax. Arizona has a transaction privilege tax (TPT). Hawaii has a general excise tax (GET), and New Mexico has a gross receipts tax (GRT). Still, the general concept remains the same.
Moreover, taxing authorities sometimes provide a sales tax deduction to benefit specific types of businesses or in response to certain circumstances. To wit, Colorado created a temporary restaurant and bar special sales tax deduction to help businesses badly affected by the COVID-19 pandemic. Businesses that qualified for this unique sales tax deduction were allowed to retain and spend the state sales tax collected during a three-month period.
What’s the difference between a deduction and an exemption?
“In some ways the term deduction means the same for federal income tax purposes as for sales tax purposes,” explains Peterson, “but the difference is significant.”
“With the federal income tax, the intent of a tax deduction is to get to net taxable income or net tax owed. Sales tax deductions are intended to allow a business to explain why the sales tax they remit matches their taxable sales and not their gross sales, unless those two numbers are the same. A deduction for sales tax purposes is how someone officially represents an exemption in the sales tax law.”
A sales tax exemption typically occurs for one of three reasons:
1. The product or service is statutorily exempt from sales tax (e.g., diapers are exempt from Florida sales tax)
2. The buyer or seller qualifies for an exemption (e.g., federal and Texas government agencies are automatically exempt from Texas sales tax)
3. The use is exempt (e.g., items purchased for resale are exempt from Illinois sales tax)
There tend to be very few deductions at the state level but lots of exemptions. All exemptions must be deducted from gross receipts on a sales tax return.
Do all states provide the same exemptions?
Exemptions vary from state to state. Unless a transaction is statutorily exempt, like the sale and use of diapers in Florida, the buyer typically needs to provide the seller with a valid exemption certificate or resale certificate as proof that they’re not required to pay the sales tax.
What is a sales tax exclusion?
Most states also provide a number of sales tax exclusions, which are similar but different from deductions and exemptions. A sales tax exclusion is similar to a statutory sales tax exemption in that no tax applies to the transaction. However, with a sales tax exclusion, the taxpayer has to prove the transaction isn’t taxable.
For example, delivery charges are excluded from Kansas sales tax so long as the seller separately states the delivery charges on the customer invoice — but the combined state and local sales tax rate applies to delivery charges that aren’t separately listed.
Should I deduct sales tax?
For income tax purposes, it’s generally in your best interest to take advantage of the tax deductions available to you. For sales tax, it would be a mistake to not deduct your exempt sales from your sales tax return.
Business records need to account for what you’ve spent and what you’ve sold, regardless of what type of deduction you’re claiming. Take state sales tax returns. “You have to keep track of exempt sales to complete your tax return accurately,” explains Scott Peterson. “Your numbers have to match. If you have $10,000 in gross sales but made $5,000 in exempt sales, you have to be able to deduct the exempt sales from your total sales to get to the right amount of tax.”
Which deductions should I take?
If you’re not a tax expert yourself and you aren’t sure where to start, an accounting professional can help you find and understand the tax deductions available to you. Many firms, even small accounting practices, now offer tax advisory services and tax compliance services.
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