| Pub. 17, Your Federal Income Tax |
2004 Tax Year |
Chapter 24 - Taxes
This is archived information that pertains only to the 2004 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.
What's New
General sales tax deduction. You can elect to deduct state and local general sales taxes instead of state and local income taxes as an itemized deduction
on Schedule A (Form
1040).
Reminder
Limit on itemized deductions. If your adjusted gross income is more than $142,700 ($71,350 if you are married filing separately), the overall amount of
your itemized deductions
may be limited. See chapter 31 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),
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General sales taxes (state and local),
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Real estate taxes (state, local, and foreign),
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Personal property taxes (state and local), and
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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:
Form (and Instructions)
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Schedule A (Form 1040)
Itemized Deductions
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Schedule E (Form 1040)
Supplemental Income and Loss
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Form 1116
Foreign Tax Credit
The following two tests must be met for any tax to be deductible by you.
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 the date of payment, provided the check is honored by the financial institution. 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.
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. You can elect to deduct state and local general sales taxes instead of 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.
Your deduction may be for withheld taxes, estimated tax payments, or other tax payments as follows.
Withheld taxes.
You can deduct state and local income taxes withheld from your salary in the year they are withheld. For 2004, 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.
You can deduct estimated tax payments you made during the year to 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.
You can deduct any part of a refund of prior-year state or local income taxes that you chose to have credited to your
2004 estimated state or local
income taxes.
Do not reduce your deduction by either of the following items.
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 Schedule A (Form 1040), line 5.
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California Nonoccupational Disability Benefit Fund.
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New Jersey Nonoccupational Disability Benefit Fund.
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New Jersey Unemployment Compensation Fund.
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New York Nonoccupational Disability Benefit Fund.
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Rhode Island Temporary Disability Benefit Fund.
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Washington State Supplemental Worker's Compensation Fund.
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West Virginia Unemployment 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 Form 1040, line 10, 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
Form 1040, line 10, in the
year you receive the refund. For a discussion of how much to include, see Recoveries in chapter 13.
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, see Publication 54, Tax Guide for U.S. Citizens and Resident
Aliens Abroad. For
information on the foreign tax credit, see Publication 514.
You can elect to deduct state and local general sales taxes, instead of state and local income taxes, as an itemized deduction
on Schedule A (Form
1040). You can deduct either your actual expenses or an amount figured using the Optional State Sales Tax Tables in Publication
600. If you use the
Optional State Sales Tax Tables, you may be able to add to the table amount any state and local general sales tax you paid
on motor vehicles, boats,
and other items specified in Publication 600. See the Instructions for Schedule A (Form 1040) for details.
Deductible real estate taxes are any state, local, or foreign taxes on real property levied for the general public welfare.
You can deduct these
taxes only if they are based on the assessed value of the real property and 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 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.
Worksheet 24-1.
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1.
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Enter the total real estate taxes for the real property tax year
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2.
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Enter the number of days in the real property tax year that you owned the property
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3.
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Divide line 2 by 366 (for regular years, divide line 2 by 365)
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.
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4.
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Multiply line 1 by line 3. This is your deduction. Enter it on Schedule A (Form 1040), line 6
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| Note. Repeat steps 1 through 4 for each property you bought or sold during the real
property tax year.
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Real estate taxes for prior years.
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 127 days (January 1 to May 6, the day before the
sale). They figure
their deduction for taxes on their old home as follows.
Since the buyers of their old home paid all of the taxes, Dennis and Beth also include the $215 in the selling price of the
old home. (The
buyers add the $215 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.
Since Dennis and Beth paid all of the taxes on the new home, they add $246 ($732 paid less $486 deduction) to their cost of
the new home. (The
sellers add this $246 to their selling price and deduct the $246 as a real estate tax.)
Dennis and Beth's real estate tax deduction for their old and new homes is the sum of $215 and $486, or $701. They will enter
this amount on
Schedule A (Form 1040), line 6.
Example 2.
George and Helen Brown bought a new home on May 3, 2004. Their real property tax year for the new home is the calendar year.
Real estate taxes for
2003 were assessed in their state on January 1, 2004. The taxes became due on May 31, 2004, and October 31, 2004.
The Browns agreed to pay all taxes due after the date of purchase. Real estate taxes for 2003 were $680. They paid $340 on
May 31, 2004, and $340
on October 31, 2004. These taxes were for the 2003 real property tax year. The Browns cannot deduct them since they did not
own the property until
2004. Instead, they must add $680 to the cost of their new home.
In January 2005, the Browns receive their 2004 property tax statement for $752, which they will pay in 2005. The Browns owned
their new home during
the 2004 real property tax year for 243 days (May 3 to December 31). They will figure their 2005 deduction for taxes as follows.
The remaining $253 ($752 paid less $499 deduction) of taxes paid in 2005, along with the $680 paid in 2004, is added to the
cost of their new
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 2004 tax deduction of
$933. This is the sum of the $680 for 2003 and the $253 for the 123 days the seller owned the home in 2004. The seller must
also include the $933 in
the selling price when he or she figures the gain or loss on the sale. The seller should contact the Browns in January 2005
to find out how much real
estate tax is due for 2004.
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
on Form 1099-S, box 5. 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 federal 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 2004 of real estate taxes you paid in 2004, you must reduce your deduction by
the amount refunded to you. If
you receive a refund or rebate in 2004 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.
One-half of self-employment tax paid.
|
Federal income taxes.
Employee contributions to private or voluntary
disability plans.
State and local general sales taxes (if you choose to deduct state and local income taxes).
|
| General Sales Taxes |
State and local general sales taxes.
|
State and local income taxes (if you choose to deduct state and local general sales taxes).
|
| 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.
|
Import duties.
|
| Other Taxes |
Taxes that are expenses of your trade or business
or of producing income.
Taxes on property producing rent or royalty
income.
Occupational taxes. See chapter 30.
|
State and local sales and use taxes.
Federal excise taxes, such as telephone taxes
(see Taxes and Fees You Cannot Deduct).
Per capita taxes.
|
| 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, car inspections, parking, or charges for water bills (see Taxes and Fees You Cannot Deduct).
|
| |
|
Fines and penalties.
|
Real Estate-Related Items You Cannot Deduct
Payments for the following items generally are not deductible as real estate taxes.
-
Taxes for local benefits.
-
Itemized charges for services (such as trash and garbage pickup fees).
-
Transfer taxes (or stamp taxes).
-
Rent increases due to higher real estate taxes.
-
Homeowners' association charges.
Taxes for local benefits.
Deductible real estate taxes generally do not include taxes charged for local benefits and improvements tending to
increase the value of your
property. These include assessments for streets, sidewalks, water mains, sewer lines, public parking facilities, and similar
improvements. You should
increase the basis of your property by the amount of the assessment.
Local benefit taxes are deductible only if they are for maintenance, repair, or interest charges related to those
benefits. If only a part of the
taxes is for maintenance, repair, or interest, you must be able to show the amount of that part to claim the deduction. If
you cannot determine what
part of the tax is for maintenance, repair, or interest, none of it is deductible.
Taxes for local benefits may be included in your real estate tax bill. If your taxing authority (or mortgage lender)
does not furnish you a copy of
your real estate tax bill, ask for it. You should use the rules above to determine if the local benefit tax is deductible.
Itemized charges for services.
An itemized charge for services to specific property or people is not a tax, even if the charge is paid to the taxing
authority. For example, you
cannot deduct the charge as a real estate tax if it is:
-
A unit fee for the delivery of a service (such as a $5 fee charged for every 1,000 gallons of water you use),
-
A periodic charge for a residential service (such as a $20 per month or $240 annual fee charged to each homeowner for trash
collection),
or
-
A flat fee charged for a single service provided by your government (such as a $30 charge for mowing your lawn because it
was allowed to
grow higher than permitted under your local ordinance).
You must look at your real estate tax bill to determine if any nondeductible itemized charges, such as those just listed,
are included in the bill.
If your taxing authority (or mortgage lender) does not furnish you a copy of your real estate tax bill, ask for it.
Exception.
Service charges used to maintain or improve services (such as trash collection or police and fire protection) are
deductible as real estate taxes
if:
-
The fees or charges are imposed at a like rate against all property in the taxing jurisdiction,
-
The funds collected are not earmarked; instead, they are commingled with general revenue funds, and
-
Funds used to maintain or improve services are not limited to or determined by the amount of these fees or charges collected.
Transfer taxes (or stamp taxes).
Transfer taxes and similar taxes and charges on the sale of a personal home are not deductible. If they are paid by
the seller, they are expenses
of the sale and reduce the amount realized on the sale. If paid by the buyer, they are included in the cost basis of the property.
Rent increase due to higher real estate taxes.
If your landlord increases your rent in the form of a tax surcharge because of increased real estate taxes, you cannot
deduct the increase as
taxes.
Homeowners' association charges.
These charges are not deductible because they are imposed by the homeowners' association, rather than the state or
local government.
Personal property tax is deductible if it is a state or local tax that is:
-
Charged on personal property,
-
Based only on the value of the personal property, and
-
Charged on a yearly basis, even if it is collected more or less than once a year.
A tax that meets the above requirements can be considered charged on personal
property even if it is for the exercise of a privilege. For example, a yearly tax based on value qualifies as a personal property
tax even if it is
called a registration fee and is for the privilege of registering motor vehicles or using them on the highways.
If the tax is partly based on value and partly based on other criteria, it may qualify in part.
Example.
Your state charges a yearly motor vehicle registration tax of 1% of value plus 50 cents per hundredweight. You paid $32 based
on the value ($1,500)
and weight (3,400 lbs.) of your car. You can deduct $15 (1% × $1,500) as a personal property tax because it is based on the
value. The remaining
$17 ($.50 × 34), based on the weight, is not deductible.
Taxes and Fees You Cannot Deduct
Many federal, state, and local government taxes are not deductible because they do not fall within the categories discussed
earlier. Other taxes
and fees, such as federal income taxes, are not deductible because the tax law specifically prohibits a deduction for them.
See Table 24-1.
Taxes and fees that are generally not deductible include the following items.
-
Estate, inheritance, legacy, or succession taxes. However, you can deduct the estate tax attributable to income in respect of a
decedent if you, as a beneficiary, must include that income in your gross income. In that case, deduct the estate tax as a
miscellaneous deduction
that is not subject to the 2%-of-adjusted-gross-income limit. For more information, see chapter 4.
-
Federal income taxes. This includes taxes withheld from your pay.
-
Fines. You cannot deduct penalties for violation of any law, including forfeiture of related collateral deposits.
-
Gift taxes.
-
License fees. You cannot deduct license fees for personal purposes (such as marriage, driver's, and dog license fees).
-
Per capita taxes. You cannot deduct state or local per capita taxes.
-
Social security. This includes social security, Medicare, or railroad retirement taxes withheld from your pay.
-
Social security and other employment taxes for household workers. However, the social security and other employment taxes you pay
on the wages of a household worker may qualify as medical or child care expenses. For more information, see chapters 23 and
34.
Many taxes and fees other than those listed above are also nondeductible, unless they are ordinary and necessary expenses
of a business or income
producing activity. For other nondeductible items, see Real Estate-Related Items You Cannot Deduct, earlier.
You deduct taxes on the following schedules.
State and local income taxes.
These taxes are deducted on Schedule A (Form 1040), line 5, even if your only source of income
is from business, rents, or royalties. You must check box a on line 5. If you deduct these taxes, you cannot elect to deduct
general sales taxes.
General sales tax deduction.
These taxes are deducted on Schedule A (Form 1040), line 5. If you elect to deduct these taxes,
you cannot deduct state and local income taxes. You must check box b on line 5.
Foreign income taxes.
Generally, income taxes you pay to a foreign country or U.S. possession can be claimed as an itemized deduction on
Schedule A (Form 1040), line 8,
or as a credit against your U.S. income tax on Form 1040, line 50. To claim the credit, you may have to complete and attach
Form 1116. For more
information, see chapter 39, the Form 1040 instructions, or Publication 514.
Real estate taxes and personal property taxes.
These taxes are deducted on Schedule A (Form 1040), lines 6 and 7, unless they are
paid on property used in your business in which case they are deducted on Schedule C or Schedule F (Form 1040). Taxes on property
that produces rent
or royalty income are deducted on Schedule E (Form 1040).
Self-employment tax.
Deduct one-half of your self-employment tax on Form 1040, line 30.
Other taxes.
All other deductible taxes are deducted on Schedule A (Form 1040), line 8.
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