If you can't beat 'em, join 'em. That philosophy works well in tax season, when you can use some tax payments to lower your IRS bill.
By itemizing deductions, you can subtract many nonfederal taxes you pay from your federal income. The less income you have, the less you owe Uncle Sam.
State Bills Lower Federal Taxes
For folks who itemize, allowable deductions include state and local income taxes or, for some filers, sales taxes paid throughout the year, along with real estate taxes, personal property taxes and intangible taxes on investments.
If you paid estimated taxes to your state revenue department, don't forget to add those amounts to the state income taxes that were withheld from your paychecks throughout the year.
And taxpayers in California, New Jersey, New York, Rhode Island and Washington may deduct mandatory payments made to those states' disability and compensation funds. Employee contributions to private or voluntary disability programs are not deductible.
Schedule A even offers itemizing taxpayers a catchall line (line 8) for "other" taxes. Here you can deduct occupational taxes or any foreign income taxes.
Foreign taxes are not that unusual, especially for investors whose holdings include mutual funds that invest -- and pay dividend taxes -- overseas. If that's the case, you'll find the foreign tax amount in box 6 of the Form 1099-DIV that your fund manager has sent you. This amount may be worth more tax savings to you, however, as a credit on line 47 of your Form 1040.
Don't Go Overboard
But don't get carried away in deducting taxes. There are some payments that Uncle Sam won't allow you to subtract from your federal income, including:
- Federal excise taxes.
- Social Security and Medicare, or FICA, taxes.
- Federal unemployment, or FUTA, and railroad retirement, or RRTA, taxes.
- Customs duties.
- Federal estate and gift taxes.
- State gasoline taxes.
- Car registration and inspection fees.
- Transfer, or stamp, taxes on the sale of property.
- License fees, such as driver's, marriage or pet tags.
- Assessments for sidewalks or other property improvements.
- Parking and traffic tickets or other fines.
- And if you paid any tax penalties or interest, sorry. These charges aren't deductible either.
Property Taxes Must be Itemized
Previously, homeowners who claimed the standard deduction were allowed to add at least some of their real estate tax payments to their standard deduction amount. That's no longer an option.
The add-on of property taxes to the standard amount expired at the end of the 2009 tax year, and it was not part of the tax bill enacted in December 2010 extending other tax breaks.
So to deduct property taxes on your 2010 tax return, you must itemize.
Deducting vehicle sales taxes
Another standard tax deduction addition also is gone for 2010 taxes.
Individuals who bought a new vehicle between Feb. 17, 2009, and Dec. 31, 2009, were allowed to include that sales tax as part of their standard deduction on their 2009 tax return. There's no such choice for standard deduction filers this filing season unless you bought the vehicle in 2009 and didn't pay the tax until 2010. In that case, you account for it on the 2010 version of Schedule L.
But a long-standing sales tax addition for taxpayers who itemize remains. If you bought a motor vehicle in 2010, sales tax paid on that purchase can be added to the rest of the sales tax amount you deduct on Schedule A.
And what, in the IRS' estimation, is a motor vehicle? The definition includes cars, motorcycles, motor homes, recreational vehicles, sport utility vehicles, trucks, vans and off-road vehicles. You also can deduct the sales tax paid on a plane or boat if the tax rate was the same as your state's general sales tax rate.
Just add the vehicle's (or boat's or plane's) sales tax amount to the state and local sales tax amount you enter on line 5b of Schedule A. For most filers, the amount of general sales tax is found in the tables provided for each state in the Schedule A instructions.
And your total deductible sales tax amount -- your state taxes, any local sales taxes and motor vehicle sales tax additions -- is calculated using the general sales tax deduction worksheet that's also found in the Schedule A instructions.