Should you Deduct State Income Tax or Sales Taxes on your 2016 Return?

Should you Deduct State Income Tax or Sales Taxes on your 2016 Return?

Most of us just finished filing our 2015 taxes, so you might think it is too early to focus on deductions for 2016. However, if you wait until next year, there is some potential tax saving opportunities you could miss out on. One area that requires some advance planning is deciding if you will deduct state income tax or sales tax on your return next year.

If you live in a state that does not have income tax, this is clearly a no-brainer, and you are likely already saving your sales tax receipts. But if your state has both income and sales tax (which most do), it is a good idea to take some time to examine your taxes both ways and decide which will be better for you. Here are some important considerations in this area:

What is your State Income Tax Rate?

The first thing to look at when deciding on income tax vs. sales tax is the income tax rate in your state. In most states, there will be several tax brackets, and the one you fall into depends on your taxable income. For example, in Arizona, there are five tax brackets, and the highest bracket is 4.54%, making it the 13th lowest among states that levy an income tax. This means an Arizona resident with an income of $100,000 will pay $4540 in income tax.

What is your State Sales Tax Rate?

Tax ReturnThe next thing to consider is the sales tax rate in your state. Using Arizona as an example again, the state sales tax rate is 5.6%, and counties, cities and special districts have the right to add their own tax on top of the state tax rate. Assuming you earn $100,000, live in an area of Arizona that does not have an additional municipal sales tax, and spend $50,000 per year on taxable goods and services (this would exclude most foods and interest on mortgage payments are deducted elsewhere on your Form 1040), you would pay $2800 in sales tax. So in this example, you would be better off deducting your income tax.

Do you Plan to make any Major Purchases this Year?

The calculations can change dramatically if you anticipate a major purchase during the coming year. The most common example is a vehicle. For example, if you purchased a new vehicle in Arizona for $40,000, your sales tax for that one item would be $2240. Assuming you still spend $50,000 on additional taxable goods and services, your total sales tax for the year would be $5040. Under this scenario, you would be able to deduct an additional $500 by choosing the sales tax option. $500 may not seem like much, but even small deductions can sometimes be the difference in bringing you into a lower tax bracket, which can produce even greater savings.

If you believe you might be in a position to benefit from deducting sales tax next year, it is important to start planning now. Collect all of your receipts from purchases and keep them in a separate file box so they are safely stored for tax season. You may also want to take a photo copy of each receipt and save it electronically, either in a folder on your smartphone, computer and/or cloud storage provider. If you are not sure if you should deduct state income or sales tax next year, speak to a tax professional about your specific circumstances and which option would be best for you.

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