New deductions are beneficial but tricky to understand; here are a few tips

A new deduction this year has some taxpayers seeing dollar signs, while others are seeing only question marks.

Last October, Congress passed a law allowing taxpayers who itemize deductions on their federal income tax return to choose whether to deduct the amount they paid for state and local income tax or the amount they paid for state and local sales tax.

The new law is a boon for most Washington residents because they don’t pay state income tax, so they haven’t been able to claim such a deduction in the past.

“This new law provides more equality for those who live in Washington and the other states that don’t have state income tax,” said Kevin Sell, tax director for the Spokane office of Seattle-based accounting firm Moss Adams.

However, Margaret Smith, budget analyst for the Spokane County Budget Office, said she’s getting phone calls and e-mail inquiries from frustrated and confused citizens regarding the new deduction — at least a dozen such inquiries in the last two weeks.

Smith said she expects the calls to continue to increase as April 15—the deadline for filing federal income tax returns—draws near.

“Most of the people I’ve talked to are just frustrated,” Smith said. “They’ve called the (Washington state) Department of Revenue, they’ve looked at the IRS (Internal Revenue Service) Web site, and they still have questions.”

One caller, for instance, lives in an unincorporated area of Spokane County located outside of the public transportation benefit area (PTBA), which means his local sales tax totals 7.8 percent. He claims, though, that he made most of his purchases in the city of Spokane, which has a higher local sales tax. He wanted to know which percentage he should use.

Meanwhile, those living within Spokane city limits and other local incorporated areas paid sales tax of 8.1 percent for a majority of last year. Spokane County voters, however, approved a 0.3 percent sales tax hike last September to fund the Spokane Transit Authority, which increased the sales tax in most areas of the county to 8.4 percent as of Oct. 1. Some callers have asked which figure they should use.

It may not affect you

Some of that confusion can be partially negated.

If you, the taxpayer, typically claim a standard deduction on your federal income tax return, then the whole sales-tax deduction question is irrelevant. The deduction can only be claimed by people who itemize their deductions, which accounts for about 30 percent of taxpayers, says Moss Adams’ Sell.

Nicholas Knapton, an attorney and CPA who’s with the Spokane accounting firm McDirmid, Mickkelsen & Secrest, said it’s also important to note that those who own property or who work outside of Washington must pay income tax in that other state, assuming it has an income tax. So, say you live and work in Spokane, but still own a family farm in Montana, it could be more beneficial for you to deduct the state income tax you pay there rather than deducting sales tax. You can’t deduct both.

How much can I deduct?

If you saved all of your sales receipts during 2004, just total up the sales tax you paid and deduct that amount. There’s no need to determine state and local sales tax rates.

You must have kept your actual receipts to use that method, though. And since the sales tax deduction wasn’t signed into law until last October, it’s unlikely most people saved such receipts.

Sell recommends hanging on to all of your receipts this year because the sales-tax deduction is available for 2005 federal income tax returns, as well. At this point, the deduction is set to expire after 2005, but lawmakers are working to extend that deadline, Knapton said.

Knapton added that the decision on whether to save sales receipts throughout the year for tax purposes hinges on whether “you’re a big saver or a big spender.”

Big savers are better off using the tables provided by the IRS, which likely would produce a higher deduction than the person actually paid in sales tax throughout the year. Big spenders are better off saving their receipts, which could add up to more than the deduction listed on the IRS tables.

How do you use sales tax table?

Assuming you didn’t save your receipts during 2004, you have to use the IRS sales-tax tables, which are contained in publication 600 and available on the agency’s Web site.

Knapton agreed there has been a lot of confusion caused by the new sales-tax deduction and “much of that confusion lies in the IRS table.”

To use the table, begin by finding your state — they’re listed alphabetically.

Then, determine your total income, which is the amount shown on your Form 1040, line 37, plus any nontaxable items such as tax-exempt interest, veteran’s benefits, workers’ compensation, and public assistance payments. Then, find the range that applies to you on the “At least – but less than” column on the left-hand side of the table.

Next, go to the column at the top of the table that includes the total number of exemptions. Find the number of exemptions you claimed on our Form 1040, line 6d.

Determine where the two columns intersect—”like playing Battleship,” Knapton quipped. The figure found at the intersection of the columns represents the amount you can deduct for 2004 state sales tax.

For instance, a Spokane couple with total income of $55,000 and four exemptions can deduct $879 in state sales tax.

Don’t forget the local deduction

Now comes the tricky part. That couple also is entitled to deduct their local sales tax.

To figure that amount, you have to use the general sales tax deduction worksheet that’s also contained in IRS publication 600.

Local sales tax is based on the sales tax rate where you live, Sell said. Moss Adams has prorated the sales tax rate for most people living in the city of Spokane (since the sales tax rate changed part way through the year) and is using a figure of 1.68 percent.

“For people living in the unincorporated portions of the county, it could be completely different,” Sell said.

According to a chart posted on the Spokane County Web site, people living in Airway Heights, Cheney, Medical Lake, Millwood, the city of Spokane, Liberty Lake, Spokane Valley, and the unincorporated areas of the county that are located within the PTBA had a local sales tax rate of 1.6 percent from January through September of 2004.

The sales tax rate in each of those jurisdictions rose to 1.9 percent in October 2004. (To get the local rate subtract 6.5 — the state’s portion of the sales tax — from the number listed for your jurisdiction on the chart).

People living in Deer Park, Fairfield, Latah, Rockford, Spangle, Waverly, and unincorporated areas outside of the PTBA had a local sales tax rate of 1.3 percent for all of 2004.

If you’re uncertain about the sales tax rate where you live, Knapton advises consulting a tax specialist.

Now back to the IRS worksheet. Our couple lives in Spokane, so they would use the prorated sales tax rate of 1.68 percent and therefore enter .0168 on line 2a of the IRS worksheet. Enter .065 (the state’s portion of the sales tax) on line 2b. Divide the amount on line 2a by the amount on line 2b and enter the result (.258) on line 2c. Then, multiply the state sales tax figure from the table ($879) by the amount on line 2c. The couple’s local sales tax is $226.78.

Now, the couple must add state and local sales tax together for a total deduction for general sales tax of $1,105.78.

However, if the couple bought a vehicle, RV, boat, or an off-road vehicle, they can add to their general sales tax figure the sales tax from the purchase of that vehicle. They also can add the sales tax from any materials purchased for home-improvement projects, said Sell.

“We’re seeing a lot of people who have been able to take advantage of that,” he said.

Once any additional sales tax from such items has been added to the state and local sales tax, the worksheet is complete and you can enter your total deduction on the Schedule A (Form 1040), line 5.