If you're shopping for a new set of wheels, don't forget the sales tax you'll be paying for that big-ticket item. This can add more than a thousand bucks to the final price and, if you finance your purchase, can bump your monthly payments higher. Fortunately, for some buyers, a sales tax deduction on their federal returns will relieve some of the financial pain.
New and Used Cars
States that assess sales tax on retail purchases also apply it to the sale of a car, and it's not a small part of their annual tax receipts. Whether you buy new or used, from a dealer or a private party, you're obligated to pay sales tax in these states, either separately from any financing you arrange or by rolling it into the total loan balance -- the same goes for leased vehicles. As of 2012, Alaska, Delaware, Montana, New Hampshire and Oregon charged their shoppers no sales tax.
Deductions and Financing
The Internal Revenue Service allows you to deduct sales taxes you pay on cars and other items, whether you finance the tax or not, but you must itemize deductions to do this. You can't take a standard deduction and also write off sales taxes. The tax is considered charged to you in the year of your purchase, even if you finance the cost to ease the payments. You can take the deduction only in that year; you can't spread it over the life of the loan.
The Two Percent Rule
The IRS classifies sales tax as a miscellaneous itemized deduction. You can't deduct any interest on the tax if you finance it. In combination with other such deductions, you can only write off the portion that exceeds 2 percent of your adjusted gross income. If your AGI is $50,000, for example, and you can only dig up $800 of miscellaneous deductions, then you're under the 2 percent threshold and you can't deduct anything by itemizing. The alternative standard deduction -- $5,950 for individuals and $11,900 for married, filing jointly as of 2012 -- would be the way to go.
Income or Sales Tax
You itemize sales tax and other deductions on Schedule A of your Form 1040. The IRS gives you the option of deducting sales tax or state income tax; you can't write off both. In states with no income tax or where the income tax rate is low, it's to your advantage to deduct the sales tax. You can either claim the precise amount of tax you paid -- meaning you have to keep receipts from every taxed purchase -- or take the standard sales-tax deduction from a set of tables published by the IRS. If your state charges a higher sales tax for cars, you can only deduct the amount you would have paid at the general sales tax rate.
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