the Election to Deduct State and Local Sales Tax
Mark H. Levin
2005 - The American Jobs Creation Act of 2004 (AJCA), section
501(a), creates an opportunity for individual taxpayers
to deduct, in computing their taxable income, the amount
of state and local sales taxes paid, in lieu of state and
local income taxes paid. This election is available for
2004 and 2005.
provision was designed to benefit taxpayers in states with
no state sales tax, taxpayers in states that impose a sales
tax that is relatively high compared with the state’s
income tax rate, and low-income taxpayers. The provision’s
effects, however, reach even further.
and Local Deductions and Federal Itemized Deductions
ability to deduct state and local sales taxes in lieu of
state and local income taxes can lower the federal income
tax for taxpayers residing in states with a low income-tax
rate. Some taxpayers residing in states with high sales
and income tax rates may, however, also benefit from electing
to deduct state and local sales taxes in lieu of state and
local income taxes. This is because most states that start
with federal taxable income in computing state taxable income
require the taxpayer to reduce federal itemized deductions
by any amount attributable to state and local income taxes.
New York State Tax Law, section 615(a)(1), requires a taxpayer
to reduce federal itemized deductions by “income taxes
imposed by this state or any other taxing jurisdiction”
when computing New York State taxable income. There is no
corresponding provision in the law requiring a reduction
for state and local sales taxes. The California Revenue
& Tax Code, section 17220(a), states: “Section
164(a)(3) of the Internal Revenue Code, relating to the
deductibility of state, local, and foreign income ... taxes
shall not apply.” Other states have similar provisions
requiring state and local income taxes, which were deducted
in comparative federal taxable income, to be added back
in arriving at state or local taxable income.
residing in states whose income tax is based on adjusted
gross income (e.g., New Jersey and Pennsylvania) will not
realize any benefit from electing to deduct state and local
sales taxes in lieu of state and local income taxes unless
the potential state and local sales tax deduction exceeds
the deduction for state and local income taxes.
and Local Deductions and the Alternative Minimum Tax
the following hypothetical set of facts: A New York resident
taxpayer is subject to the federal alternative minimum tax
(AMT). Her AMT taxable income (AMTI) is greater than the
state and local income tax deduction claimed in her federal
tax return. The taxpayer has an AMTI of $40,000, a state
and local income tax deduction of $15,000, and a potential
sales taxes deduction of $5,000.
the taxpayer elects to deduct the $5,000 state and local
sales tax in lieu of the $15,000 state and local income
tax, there will be no change to her federal income tax,
as neither state and local income taxes nor state and local
sales taxes are deductible for AMT purposes. There is no
requirement, however, to reduce the federal itemized deductions
by state and local sales taxes when computing the New York
State personal income tax, so the New York State taxable
income will be lower with the federal deduction for state
and local sales taxes than if the taxpayer had taken a federal
deduction for state and local income taxes.
must be taken when preparing 2004 and 2005 tax returns to
ensure that the taxpayer is getting the benefit of whichever
of the above deductions will result in the lowest combined
federal, state, and local income tax.
H. Levin, CPA, is manager, state and local taxes,
at H.J. Behrman & Company, LLP, New York, N.Y.