As you might recall, the new sales tax deduction was brought about with the American Jobs Creation Act of 2004 that was passed in late 2004. In effect, this new law allows for the deduction of either state sales taxes or state income taxes, whichever is greater. The IRS recently issued Publication 600, Optional State Sales Tax Tables, reflecting the deduction provided for state sales taxes for each state given your income and exemptions. You'll want to take a look at this publication since there are instructions and worksheets that will help you with the computation of your sales tax deduction. Remember that the optional deduction for sales taxes is effective only for 2004 and 2005. So, unless Congress acts in the near future, your ability to deduct sales taxes will sunset after the 2005 tax year.

Much has been made in print and the airwaves about the new sales tax deduction. Much of the information disseminated has been false or misleading. Let's take a few minutes to review this new deduction in order to separate fact from fiction.

Fact: You're allowed this deduction only if you itemize your deductions on Schedule A. If you claim the standard deduction on your federal tax return, you'll receive no benefit from the new sales tax deduction. It applies only to those taxpayers who itemize.

Fiction: You are allowed to deduct both your sales taxes and your state income taxes. In fact, the law is very clear on this point: You can choose one or the other, but not both. So you'll have to determine the deduction that provides you with the greatest benefit. But in no circumstances can you deduct both sales taxes and state income taxes.

Fact: You can use the greater of the actual sales taxes you paid or the deduction allowed in IRS Publication 600 tables. For those of you who keep all of your records and receipts throughout the year for all of the things that you purchased, you can add up your appropriate sales taxes and use that as your deductible amount. The IRS provides the tables simply for the ease of claiming this deduction for those of us who might not be as diligent in saving records and receipts on a daily basis. But with ease sometimes comes pain. In my review of the sales tax tables, it appears that the deduction is lower than would normally be expected given the various income categories. So if you have maintained your purchase records throughout the year, it might be a good idea to add up your sales taxes and compare them to the table deduction. You might be surprised, even if your sales tax records aren't perfectly complete.

Fiction: Only those people living in nontax states (i.e., Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) will benefit from this new law. Not hardly. In reviewing the tables, many low-income taxpayers with a high number of dependents will find that their optional sales tax deduction will be far greater than their state tax deduction. For example, an Arizona married couple with three dependent children and income of $31,000 would have an Arizona state tax liability of about $280 but would have an optional sales tax deduction amount of $654.

Fiction: Always use your state tax deduction if it's greater than your sales tax deduction. Remember that if you have a refund of state taxes, that refund will be considered income on your federal tax return in the following year. On the other hand, if you have a refund of state taxes when using the sales tax deduction, none of your state refund will be considered a recapture of a prior deduction. That being the case, none of that refund will be as income in the following year. Because of this circumstance, you'll want to think twice if your sales tax deduction is near your state tax deduction.

Fact: You can add various "big ticket" items to the results found in the tables in Publication 600. But those so-called "big ticket" items are well-defined. They don't include furnishings or that new big-screen plasma TV for your entertainment unit. But they do include sales taxes on motor vehicles (including cars, motorcycles, motor homes, recreational vehicles, sport utility vehicles, trucks, vans, and off-road vehicles). You also receive an additional deduction for sales taxes paid on a leased vehicle. And an additional sales tax deduction is allowed for the purchase of an aircraft, boat, home (including mobile homes and prefabricated homes), or home building materials. So obviously, if you purchased any qualifying "big-ticket" items in 2004, make sure to add the sales taxes paid on those items to your table amount.

Fiction: You receive no deduction for any local sales taxes. That's completely untrue. If you live in a city or local subdivision that assesses a general sales tax in addition to the normal state sales tax, there is a formula found in Publication 600 that will allow you to increase the deduction that you may claim for your combined state and local sales taxes.

Fact: If you lived in more than one state, you're allowed to claim the pro-rata share of sales taxes in each state. Publication 600 provides you with an example that you can follow in order to compute your applicable sales tax deduction from each state based upon the tables.

There really is more to the sales tax deduction than meets the eye on first blush. There will be many taxpayers living in states that impose a state income tax that will elect to use the sales tax deduction. It's not necessarily a "slam dunk" decision, even if you're using a computerized tax preparation program or even a professional tax preparer. So make yourself aware of how the sales tax deduction actually works, since the proper application of the rules could save you more than just a few tax dollars.

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