Determining the Amount of the Sales Tax
The sales tax is the actual amount paid during the year, which can be determined by the larger of:
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Actual receipts for purchases, OR
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The amount from the IRS income-based table PLUS sales tax paid when purchasing motor vehicles, boats and other items specified by the IRS.
Using the Optional Tables
The optional sales tax tables provide an amount of sales taxes paid based on a taxpayer's:
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State of residence - The state where the taxpayer physically resides;
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Total available income - AGI plus amounts not reflected in AGI that increase spendable income; and,
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Family size - The number of dependents included on the taxpayer's tax return plus the filer and spouse if filing a joint return, subject to a special rule for joint filers living in different states (see below).
The table for each state is based on the state’s sales tax rate plus, if applicable, a uniform local sales tax rate. Taxpayers residing in a jurisdiction that imposes an additional sales tax rate are allowed a proportional increase in the sales tax deduction amount found in the optional sales tax tables. See the instructions to Schedule A for the sales tax tables, a worksheet and further information.
Spendable Income
The tables provide an amount of sales taxes paid based on the taxpayer's state of residence, total available income, and family size (defined above). The state of residence is the state where the taxpayer physically resides. Total available income is adjusted gross income (AGI) plus amounts not reflected in AGI that increase spendable income, such as:
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Worker's compensation,
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Public assistance payments,
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Military compensation earned in a combat zone,
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Tax-exempt interest,
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The refundable portion of refundable tax credits,
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The nontaxable part of SS, veterans' or railroad retirement benefits, and,
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The nontaxable part of IRA, pension or annuity distributions.
Residing in Multiple States
A taxpayer who uses the tables and lives in different states during the tax year must multiply the amount determined under the tables for each state of residence by a fraction. Its numerator is the number of days the taxpayer was physically a resident in the state and its denominator is the number of days in the year. This is illustrated in an example in Notice 2005-31.
Items That Can Be Added to the Table Amount
In addition to the amount determined under the optional tables and amounts added for local general sales taxes, taxpayers may deduct allowable actual state and local general sales taxes paid on the purchase of:
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Motor vehicles, Boats, Aircraft,
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Homes (including mobile and prefabricated homes), and
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Materials to build a home.
Definition of Motor Vehicle for Sales Tax Deduction Purposes
A “motor vehicle” includes any of the following, which may be either purchased or leased:
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Automobile
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Motorcycle
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Motor home
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Recreational vehicle
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Sport utility vehicle
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Off-road vehicle
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Van
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Truck
Home Sales Tax
Sales tax is deductible where a state or locality imposes a general sales tax directly on the sale of a home or on the cost of a substantial addition or major renovation under either of the following circumstances (Schedule A Instructions (2024) Page A6):
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Taxpayer purchases the materials to build a home or substantial addition or to perform a major renovation and paid the sales tax directly.
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Under state law, the contractor is considered the taxpayer’s agent in the construction of the home or substantial addition or the performance of a major renovation. The contract must state that the contractor is authorized to act in the taxpayer’s name and must follow the taxpayer’s directions on construction decisions. In this case, the taxpayer will be considered to have purchased any items subject to a sales tax and to have paid the sales tax directly.
Sales Tax and State Tax Refund
Under the tax benefit rule, the recovery of an amount deducted or credited in an earlier tax year is included in a taxpayer's income in the current (recovery) year, except to the extent the deduction or credit didn't reduce federal income tax (or alternative minimum tax). (IRC §111(a)) For example, if a taxpayer who used the standard deduction instead of itemizing on his 2024 federal return receives a refund in 2025 from his 2024 state income tax return, that refund is not taxable on his 2025 federal return because he did not deduct the state income tax on the 2024 federal return. While the state will likely issue a Form 1099-G reporting the refund, the taxpayer does not include any of the refund amount on his federal return in this situation.
The recovery (refund) of state income tax is the most common itemized deduction recovery, but taxpayers may also recover amounts for previously deducted medical expenses, real property taxes or mortgage interest. Only itemized deductions that are more than the standard deduction are subject to the recovery rule (unless the taxpayer was required to itemize deductions). If total deductions on the earlier year return were not more than the income for that year, the recovery amount to include on the return for the recovery year is the lesser of the recoveries or the amount by which itemized deductions exceeded the standard deduction.
Where taxpayers have the option to deduct as an itemized deduction either the state (and local) income tax paid during the year or state and local sales tax, on first examination one would assume that (1) if the client chooses to deduct state income tax and subsequently receives a refund from the state, then that refund is taxable, and (2) if they choose to deduct sales tax instead of state income tax and receive a state refund for that year, that refund is not taxable. Actually, the IRS has taken a much more liberal approach to this issue. Their position is that for purposes of the tax benefit rule the amount of refund includable in income is limited to the excess of the tax the taxpayer chose to deduct over the tax they did not choose to deduct.
Example – Assume the taxpayer can choose an $8,000 state income tax deduction or a $7,000 state general sales tax deduction. Since the state income tax deduction is the larger, he chooses to deduct the state income tax. In the subsequent year he receives a $2,500 state income tax refund. Using the IRS’s more liberal approach the tax benefit derived from deducting the $8,000 state income tax was only $1,000 more than if the $7,000 sales tax deduction was used. Thus, the taxpayer benefits from only $1,000 of the state tax deduction and as a result only $1,000 of the $2,500 refund is taxable the next year.
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Strategy
In order to benefit from the IRS’ liberal tax benefit rule position, you must be able to compute the difference between the sales tax deduction and the state income tax deduction. Thus, it is important (when there is a state tax refund and the state income tax deduction exceeds the sales tax deduction) to determine the allowable sales tax deduction for the client and record it in your file. Otherwise, there is no way of computing the tax benefit rule.
Be Sure to Look Back – And take advantage of this tax benefit rule.