Since 2004, there has been a temporary provision to allow individuals to take an itemized deduction for either state income tax or state sales tax. This works well for individuals in states without an income tax. On April 16, 2015, the House passed H.R. 622, State and Local Sales Tax Deduction Fairness Act of 2015, to make this provision permanent (vote 272-152). The Joint Committee on Taxation estimates the cost of H.R. 622 at $42 billion over ten years or about $4 billion per year (JCX-41-15; 2/11/15). If the state tax deduction were not an AMT preference item, the cost would be higher. And, bear in mind, that only about one-third of individuals itemize, and most states do have an income tax which is likely to be larger than the sales tax someone pays.
Per House Report 114-51 accompanying H.R. 622, the rationale for permanence is (1) to provide certainty to individuals and (2) provide parity with individuals deducting state income tax. Arguments against the bill include the cost, lack of any revenue offset, and not looking at all of the expired provisions together.
The House Report notes that tax reform may eliminate all itemized deductions for state taxes, but the majority believes that until then, there should be parity for all itemizers regarding state tax deductions.
So, for ten years, there has been a choice of which tax to deduct (although without certainty regarding the sales tax). What about the years dating back to the Tax Reform Act of 1986, when the sales tax deduction was stripped from the Code? The reasons why TRA'86 repealed a deduction for sales tax while leaving the itemized deduction for state income taxes include the following (per pages 46-48 of the TRA'86 Bluebook):
- Sales tax mostly ties to personal purchases so it allowed a deduction for personal expenditures.
- The sales tax deduction was a small portion of the total state tax deduction. Per 1984 data, only one-fourth of sales tax was deducted in contrast to over half of state income taxes.
- Substantial recordkeeping was required for the sales tax deduction if the sales tax table was not used.
Is there any justification for allowing individuals a deduction for state taxes? Yes and no. One justification is the ability to pay concept. State taxes represent income not available for paying federal income taxes. An opposing view is that state taxes provide personal benefits so should not be deductible. [For more on the tax policy related to the state tax deduction, see Nellen, Goodbye State Tax Deduction, AICPA Tax Insider, 5/8/08.]
Some points missing from the discussion on what to do with the option of deducting sales tax:
- These deductions are likely to be repealed as part of comprehensive tax reform to help pay for lower rates and repeal of the AMT. Congress making the sales tax permanent allows for more revenue to be raised, although if extended without a revenue offset, the revenue is questionable.
- Repeal of the state tax deduction will make the law simpler. For example, Section 164(c)(5) to be made permanent by H.R. 622 is 638 words long!
- Why no focus on the property tax deduction? Why not repeal it or cut it back? While there is an ability to pay argument supporting it, the current deduction is too broad. For example, if someone lives in a very expensive home or has multiple homes, all other taxpayers subsidize that decision (regarding the property taxes paid) - why? For an extreme example, note Mitt Romney's $214,000 of real estate taxes on his 2011 return, and no mortgage interest deduction.
So, what do you think? Should the provision to allow a sales tax deduction in lieu of a state income tax deduction (for those who itemize) be made permanent?
Other recent “Sales Tax Policy - Tales & Trends” posts by Annette Nellen, CPA, ESQ:
- Sales Tax Policy Outlook for 2017
- Would Broader Sales Tax Base Deliver Simplification - and Savings?
- Trailing Nexus - When Does It End?
- Sales Tax As Penalty?
- Tax on Short-Term Rentals – Taxing on Landlords & Municipalities