| American
Jobs Creation Act of 2004 and State Income Taxes
By
Mark H. Levin
MARCH
2005 - Aprovision in the American Jobs Creation Act of 2004
could create an opportunity for taxpayers to reduce their
state income tax bill. Section 501 of the act adds IRC section
164(b)(5), which provides that taxpayers who itemize their
deductions can elect to deduct state and local general sales
taxes instead of state and local income taxes paid for 2004
and 2005. The provisions of IRC section 164(b)(5) resemble
the sales tax deduction that was in effect before 1987 and
was repealed by the Tax Reform Act of 1986. This election
presents two options: deducting the actual amount of sales
tax paid during the year (the taxpayer must retain all receipts
to substantiate the deduction), or using amounts from an
IRS-provided table, plus any sales taxes paid on motor vehicles,
boats, and other items specified by the Secretary of the
Treasury (the taxpayer must retain only the receipts for
the purchase of such items).
Most
explanations of this provision imply that the allowance,
at the taxpayer’s election, to deduct state and local
general sales taxes instead of state and local income taxes,
affects taxpayers living in states with no statewide income
taxes (Alaska, Florida, New Hampshire, Nevada, South Dakota,
Tennessee, Texas, Washington, and Wyoming). The election
to deduct sales taxes instead of income taxes, however,
may affect any taxpayer in states that base their income
tax on federal taxable income with adjustments (adjustment
states), as well as in states with a low tax rate (e.g.,
Pennsylvania).
Taxpayers
in an adjustment state must be subject to the alternative
minimum tax (AMT) to benefit from an election to deduct
state and local general sales taxes instead of income taxes.
This is possible because IRC section 56(b)(1)(A) requires
the taxpayer, in computing the AMT taxable income, to add
back to taxable income any tax described in IRC section
164(a)(3) (state and local, and foreign, income, war profits,
and excess profits taxes) and IRC section 164 (b)(5)(A)(i),
which includes, by inference, state and local general sales
taxes in IRC section 164(a)(3), causing the deduction for
state and local general sales taxes to also be added back
in computing AMT.
If
a taxpayer lives in an adjustment state and is subject to
the federal AMT, and if that state requires a taxpayer to
reduce any itemized deductions by any state and local taxes
included therein, the federal deduction of state and local
general sales taxes instead of income taxes could create
a lower state income tax if the state does not require the
deduction for state and local general sales taxes to be
added back to taxable income. Taxpayers that fit into this
fact pattern may be able to lower their state income tax
without increasing their federal income tax by deducting
state and local general sales taxes instead of income taxes.
Consider
that New York State Tax Law section 615(c)(1) requires that
taxpayers who itemize on their New York tax returns reduce
their itemized deductions by any “income taxes imposed
by this state or any other taxing jurisdiction” without
any reference to IRC code section 164. This wording would
not require taxpayers to reduce their New York State itemized
deductions by the deduction for state and local general
sales taxes.
If
a taxpayer lives in a state that has a low income tax rate,
such as Pennsylvania, which had a 2.8% rate for 2003 and
a 3.07% rate for 2004, it is possible that the state and
local general sales taxes deduction may be a higher amount
than a state and local income taxes deduction.
Preparing
tax returns has become more complex due to what at first
glance appears to affect only the federal income tax return,
but it may also affect state and local income tax returns.
Mark
H. Levin, CPA, is manager, state and local taxes,
at H.J. Behrman & Company, LLP, New York, N.Y.
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