Taxes
Important Reminder
Limit on itemized deductions.
If your adjusted gross income is more than $137,300 ($68,650 if you are married filing separately), the overall amount of your itemized deductions
may be limited. See chapter 22 for more information about this limit.
Introduction
This chapter discusses which taxes you can deduct if you itemize deductions on Schedule A (Form 1040). It also explains which taxes you can deduct
on other schedules or forms and which taxes you cannot deduct.
This chapter covers:
- Income taxes (state, local, and foreign),
- Real estate taxes (state, local, and foreign),
- Personal property taxes (state and local), and
- Taxes and fees you cannot deduct.
Use Table 24-1 as a guide to determine which taxes you can deduct.
At the end of the chapter is a section that explains which form you use to deduct the different types of taxes.
Business taxes.
You can deduct certain taxes only if they are ordinary and necessary expenses of your trade or business or of producing income. For information on
these taxes, see Publication 535, Business Expenses.
State or local taxes.
These are taxes imposed by the 50 states, U.S. possessions, or any of their political subdivisions (such as a county or city), or by the District
of Columbia.
Indian tribal government.
An Indian tribal government that is recognized by the Secretary of the Treasury as performing substantial government functions will be treated as a
state for this purpose. Income taxes, real estate taxes, and personal property taxes imposed by that Indian tribal government (or by any of its
subdivisions that are treated as political subdivisions of a state) are deductible.
Foreign taxes.
These are taxes imposed by a foreign country or any of its political subdivisions.
Useful Items You may want to see:
Publication
- 514
Foreign Tax Credit for Individuals
- 530
Tax Information for First-Time Homeowners
Form (and Instructions)
- Schedule A (Form 1040)
Itemized Deductions
- Schedule E (Form 1040)
Supplemental Income and Loss
- Form 1116
Foreign Tax Credit
Tests To Deduct Any Tax
The following two tests must be met for any tax to be deductible by you.
- The tax must be imposed on you.
- The tax must be paid during your tax year.
The tax must be imposed on you.
Generally, you can deduct only taxes that are imposed on you.
Generally, you can deduct property taxes only if you are the property owner. If your spouse owns property and pays real estate taxes on it, the
taxes are deductible on your spouse's separate return or on your joint return.
The tax must be paid during your tax year.
If you are a cash basis taxpayer, you can deduct only those taxes actually paid during your tax year. If you pay your taxes by check, the day you
mail or deliver the check is generally the date of payment. If you use a pay-by-phone account, the date reported on the statement of the financial
institution showing when payment was made is the date of payment. If you contest a tax liability and are a cash basis taxpayer, you can deduct the tax
only in the year it is actually paid.
If you use an accrual method of accounting, see Publication 538, Accounting Periods and Methods, for more information.
Income Taxes
This section discusses the deductibility of state and local income taxes (including employee contributions to state benefit funds) and foreign
income taxes.
State and Local Income Taxes
You can deduct state and local income taxes.
Exception.
You cannot deduct state and local income taxes you pay on income that is exempt from federal income tax, unless the exempt income is interest
income. For example, you cannot deduct the part of a state's income tax that is on a cost-of-living allowance that is exempt from federal income tax.
What To Deduct
Your deduction may be for withheld taxes, estimated tax payments, or other tax payments as follows.
Withheld taxes.
Deduct state and local income taxes withheld from your salary in the year they are withheld. For 2002, these taxes will be shown in boxes 17 and 19
of your Form W-2. You may also have state or local income tax withheld on Form W-2G (box 14), Form 1099-MISC (box 16), or Form
1099-R (boxes 10 and 13).
Estimated tax payments.
Deduct estimated tax payments you made during the year under a pay-as-you-go plan of a state or local government. However, you must have a
reasonable basis for making the estimated tax payments. Any estimated state or local tax payments you make that are not reasonably determined in good
faith at the time of payment are not deductible. For example, you made an estimated state income tax payment. However, the estimate of your state tax
liability shows that you will get a refund of the full amount of your estimated payment. You had no reasonable basis to believe you had any additional
liability for state income taxes and you cannot deduct the estimated tax payment.
Refund applied to taxes.
Deduct any part of a refund of prior-year state or local income taxes that you chose to have credited to your 2002 estimated state or local income
taxes.
Do not reduce your deduction by either of the following items.
- Any state or local income tax refund (or credit) you expect to receive for 2002.
- Any refund of (or credit for) prior year state and local income taxes you actually received in 2002.
However, part or all of this refund (or credit) may be taxable. See Refund (or credit) of state or local income taxes, later.
Separate federal returns.
If you and your spouse file separate state, local, and federal income tax returns, you each can deduct on your federal return only the amount of
your own state and local income tax.
Joint state and local returns.
If you and your spouse file joint state and local returns and separate federal returns, each of you can deduct on your separate federal return part
of the state and local income taxes. You can deduct only the amount of the total taxes that is proportionate to your gross income compared to the
combined gross income of you and your spouse. However, you cannot deduct more than the amount you actually paid during the year. You can avoid this
calculation if you and your spouse are jointly and individually liable for the full amount of the state and local income taxes. If so, you and your
spouse can deduct on your separate federal returns the amount you each actually paid.
Joint federal return.
If you file a joint federal return, you can deduct the total of the state and local income taxes both of you paid.
Contributions to state benefit funds.
As an employee, you can deduct mandatory contributions to state benefit funds that provide protection against loss of wages. Mandatory payments
made to the following state benefit funds are deductible as state income taxes on line 5 of Schedule A (Form 1040).
- California Nonoccupational Disability Benefit Fund.
- New Jersey Nonoccupational Disability Benefit Fund.
- New Jersey Unemployment Compensation Fund.
- New York Nonoccupational Disability Benefit Fund.
- Rhode Island Temporary Disability Benefit Fund.
- Washington State Supplemental Workmen's Compensation Fund.
Employee contributions to private or voluntary disability plans are not deductible.
Refund (or credit) of state or local income taxes.
If you receive a refund of (or credit for) state or local income taxes in a year after the year in which you paid them, you may have to include the
refund in income on line 10 of Form 1040 in the year you receive it. This includes refunds resulting from taxes that were overwithheld, applied from a
prior year return, not figured correctly, or figured again because of an amended return. If you did not itemize your deductions in the previous year,
do not include the refund in income. If you deducted the taxes in the previous year, include all or part of the refund on line 10, Form 1040, in the
year you receive the refund. For a discussion of how much to include, see Recoveries in chapter 13.
Foreign Income Taxes
Generally, you can take either a deduction or a credit for income taxes imposed on you by a foreign country or a U.S. possession. However, you
cannot take a deduction or credit for foreign income taxes paid on income that is exempt from U.S. tax under the foreign earned income exclusion or
the foreign housing exclusion. For information on these exclusions, get Publication 54, Tax Guide for U.S. Citizens and Resident Aliens
Abroad. For information on the foreign tax credit, get Publication 514.
Real Estate Taxes
Deductible real estate taxes are any state, local, or foreign taxes on real property levied for the general public welfare. The taxes must be based
on the assessed value of the real property and must be charged uniformly against all property under the jurisdiction of the taxing authority.
Deductible real estate taxes generally do not include taxes charged for local benefits and improvements that increase the value of the property.
They also do not include itemized charges for services (such as trash collection) to specific property or people, even if the charge is paid to the
taxing authority. For more information about taxes and charges that are not deductible, see Real Estate-Related Items You Cannot Deduct,
later.
Tenant-shareholders in a cooperative housing corporation.
Generally, you can deduct your share of the real estate taxes the corporation paid or incurred on the property. The corporation should provide you
with a statement showing you your share of the taxes. For more information, see Special Rules for Cooperatives in Publication 530.
Buyers and sellers of real estate.
If you bought or sold real estate during the year, the real estate taxes must be divided between the buyer and the seller.
The buyer and the seller must divide the real estate taxes according to the number of days in the real property tax year (the period to
which the tax imposed relates) that each owned the property. The seller is treated as paying the taxes up to, but not including, the date of sale. The
buyer is treated as paying the taxes beginning with the date of sale. This applies regardless of the lien dates under local law. Generally, this
information is included on the settlement statement provided at the closing.
If you (the seller) cannot deduct taxes until they are paid because you use the cash method of accounting, and the buyer of your property is
personally liable for the tax, you are considered to have paid your part of the tax at the time of the sale. This lets you deduct the part
of the tax to the date of sale even though you did not actually pay it. However, you must also include the amount of that tax in the selling price of
the property. The buyer must include the same amount in his or her cost of the property.
You figure your deduction for taxes on each property bought or sold during the real property tax year as follows.
| 1. |
Enter the total real estate taxes for the real property tax year |
|
| 2. |
Enter the number of days in the real property tax year that you owned the property |
|
| 3. |
Divide line 2 by 365 |
. |
| 4. |
Multiply line 1 by line 3. This is your deduction. Enter it on line 6 of Schedule A (Form 1040) |
|
| Note. Repeat steps 1 through 4 for each property you bought or sold during the real property tax year. |
Delinquent taxes.
Do not divide delinquent taxes between the buyer and seller if the taxes are for any real property tax year before the one in which the property is
sold. Even if the buyer agrees to pay the delinquent taxes, the buyer cannot deduct them. The buyer must add them to the cost of the property. The
seller can deduct these taxes paid by the buyer. However, the seller must include them in the selling price.
Examples.
The following examples illustrate how real estate taxes are divided between buyer and seller.
Example 1.
Dennis and Beth White's real property tax year for both their old home and their new home is the calendar year, with payment due August 1. The tax
on their old home, sold on May 7, was $620. The tax on their new home, bought on May 3, was $732. Dennis and Beth are considered to have paid a
proportionate share of the real estate taxes on the old home even though they did not actually pay them to the taxing authority. On the other hand,
they can claim only a proportionate share of the taxes they paid on their new property even though they paid the entire amount.
Dennis and Beth owned their old home during the real property tax year for 126 days (January 1 to May 6, the day before the sale). They figure
their deduction for taxes on their old home as follows.
Taxes On Old Home
| 1. |
Enter the total real estate taxes for the real property tax year |
$620 |
| 2. |
Enter the number of days in the real property tax year that you owned the property |
126 |
| 3. |
Divide line 2 by 365 |
.345 |
| 4. |
Multiply line 1 by line 3. This is your deduction. Enter it on line 6 of Schedule A (Form 1040) |
$214 |
buyers add the $214 to their cost of the home.)
Dennis and Beth owned their new home during the real property tax year for 243 days (May 3 to December 31, including their date of purchase). They
figure their deduction for taxes on their new home as follows.
Taxes On New Home
| 1. |
Enter the total real estate taxes for the real property tax year |
$732 |
| 2. |
Enter the number of days in the real property tax year that you owned the property |
243 |
| 3. |
Divide line 2 by 365 |
.666 |
| 4. |
Multiply line 1 by line 3. This is your deduction. Enter it on line 6 of Schedule A (Form 1040) |
$488 |
sellers add this $244 to their selling price and deduct the $244 as a real estate tax.)
Dennis and Beth's real estate tax deduction for their old and new homes is the sum of $214 and $488, or $702. They will enter this amount on line 6
of Schedule A (Form 1040).
Example 2.
George and Helen Brown bought a new home on May 3, 2002. Their real property tax year for the new home is the calendar year. Real estate taxes for
2001 were assessed in their state on January 1, 2002. The taxes became due on May 31, 2002, and October 31, 2002.
The Browns agreed to pay all taxes due after the date of purchase. Real estate taxes for 2001 were $680. They paid $340 on May 31, 2002, and $340
on October 31, 2002. These taxes were for the 2001 real property tax year. The Browns cannot deduct them since they did not own the property until
2002. Instead, they must add $680 to the cost of their new home.
In January 2003, the Browns receive their 2002 property tax statement for $752, which they will pay in 2003. The Browns owned their new home during
the 2002 real property tax year for 243 days (May 3 to December 31). They will figure their 2003 deduction for taxes as follows.
| 1. |
Enter the total real estate taxes for the real property tax year |
$752 |
| 2. |
Enter the number of days in the real property tax year that you owned the property |
243 |
| 3. |
Divide line 2 by 365 |
.666 |
| 4. |
Multiply line 1 by line 3. This is your deduction. Claim it on line 6 of Schedule A (Form 1040) |
$501 |
home.
Because the taxes up to the date of sale are considered paid by the seller on the date of sale, the seller is entitled to a 2002 tax deduction of
$931. This is the sum of the $680 for 2001 and the $251 for the 122 days the seller owned the home in 2002. The seller must also include the $931 in
the selling price when he or she figures the gain or loss on the sale. The seller should contact the Browns in January 2003 to find out how much real
estate tax is due for 2002.
Form 1099-S.
For certain sales or exchanges of real estate, the person responsible for closing the sale (generally the settlement agent) prepares Form
1099-S, Proceeds From Real Estate Transactions, to report certain information to the IRS and to the seller of the property. Box 2 of
the form is for the gross proceeds of the sale and should include the portion of the seller's real estate tax liability that the buyer will pay after
the date of sale. The buyer includes these taxes in the cost basis of the property, and the seller both deducts this amount as a tax paid and includes
it in the sales price of the property.
For a real estate transaction that involves a home, any real estate tax the seller paid in advance but that is the liability of the buyer appears
in box 5 of Form 1099-S. The buyer deducts this amount as a real estate tax, and the seller reduces his or her real estate tax deduction (or
includes it in income) by the same amount. See Refund (or rebate), later.
Taxes placed in escrow.
If your monthly mortgage payment includes an amount placed in escrow (put in the care of a third party) for real estate taxes, you may not be able
to deduct the total amount placed in escrow. You can deduct only the real estate tax that the third party actually paid to the taxing authority. If
the third party does not notify you of the amount of real estate tax that was paid for you, contact the third party or the taxing authority to find
the proper amount to show on your return.
Tenants by the entirety.
If you and your spouse held property as tenants by the entirety and you file separate returns, each of you can deduct only the taxes each of you
paid on the property.
Divorced individuals.
If your divorce or separation agreement states that you must pay the real estate taxes for a home owned by you and your spouse, part of your
payments may be deductible as alimony and part as real estate taxes. See Taxes and insurance, in chapter 20, for more information.
Minister's and military personnel housing allowances.
If you are a minister or a member of the uniformed services and receive a housing allowance that you can exclude from income, you still can deduct
all of the real estate taxes you pay on your home.
Refund (or rebate).
If you receive a refund or rebate in 2002 of real estate taxes you paid in 2002, you must reduce your deduction by the amount refunded to you. If
you receive a refund or rebate in 2002 of real estate taxes you deducted in an earlier year, you generally must include the refund or rebate in income
in the year you receive it. However, you only need to include the amount of the deduction that reduced your tax in the earlier year. For more
information, see Recoveries in chapter 13.
If you did not itemize deductions in the year you paid the tax, do not report the refund as income.
Table 24-1. Which Taxes Can You Deduct?
| |
You Can Deduct |
You Cannot Deduct |
| Income Taxes |
State and local income taxes. Foreign income taxes. Employee contributions to state funds listed under Contributions to state benefit funds. |
Federal income taxes. Employee contributions to private or voluntary disability plans. |
| Real Estate Taxes |
State and local real estate taxes. Foreign real estate taxes. Tenant's share of real estate taxes paid by cooperative housing corporation. |
Taxes for local benefits (with exceptions). Trash and garbage pickup fees (with exceptions). Rent increase due to higher real estate taxes. Homeowners association charges. |
| Personal Property Taxes |
State and local personal property taxes. |
|
| Other Taxes |
Taxes that are expenses of your trade or business or of producing income. One-half of self-employment tax paid. Taxes on property producing rent or royalty income. Occupational taxes. |
Many taxes, such as state and local sales taxes and federal excise taxes (see Taxes and Fees You Cannot Deduct). |
| Fees and Charges |
Fees and charges that are expenses of your trade or business or of producing income. |
Fees and charges that are not expenses of your trade or business or of producing income, such as fees for driver's licenses or charges for water bills (see Taxes and Fees You Cannot Deduct). |
