There are nine different states that don’t tax wages. For residents of the other fourth-one, tax season requires the filing of both a federal income tax return and a state return.
While paying taxes to the state may not be ideal in your mind, there’s one highlight: State taxes may be able to reduce your federal taxes. If you want to deduct your state taxes on your federal return, consider the following.
You’ll have to itemize your deductions using a Form 1040. Any state and local taxes you paid are subtracted from your adjusted gross income, which lowers the amount you are federally taxed on. Deductible taxes include:
- State income tax
- Sales tax
- Paid property tax
- State estimated taxes (paid on income not subjected to withholdings.)
Local taxes that are eligible for deduction depend on the state where you live. There are 14 states that allow cities, counties, and municipalities to create their own tax codes for workers. Residents of these states likely pay a local tax that is eligible for deduction.
You can only deduct one of the two: state income tax or state sales tax. You aren’t able to deduct both. In most cases, deducting state and local income taxes generates a better deal for taxpayers. If you made a major purchase such as a vehicle, or your state has a high sales tax rate, you may benefit more from sales tax deduction. It’s worth figuring out both options and choosing the one which gives the better deal.
If you determine state sales tax deduction is the way to go, you’ll have the option to estimate your annual payment (through the special IRS sales tax deduction calculator) or you can use your receipts to enter the actual amount of your purchases.
You’re able to deduct real estate taxes you paid, relevant to the value of your home. If you pay personal property tax on vehicles you own, you may be able to deduct those as well.
If you chose to deduct your taxes in one year, and receive a state tax refund the following year, you’ll likely need to claim the money as income. If you do, you’ll receive a Form 1099-G outlining the amount of the refund. The IRS will also receive a copy of that.
You’re able to avoid paying taxes on a state refund by not itemizing, or by deducting only state sales taxes from your income.