American Jobs Creation Act of 2004 and State Income Taxes

By Mark H. Levin

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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 The provisions of IRC section 164(b)(5) resemble the sales tax deduction that was in effect before 1987 and was repealed by the Tax Reform Act of 1986.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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