Expenses Eligible for the State Income Tax DeductionAll income taxes imposed by state, local or foreign jurisdictions are eligible to be deducted for individuals itemizing their deductions on their Schedule A. The IRS websites states the following, "To be deductible, the tax must be imposed on you and must have been paid during your tax year," (Tax Topic 503, IRS.gov). Eligible expenses that can be deducted for state and local income taxes include:
- Withholding for state and local income taxes (shown on Form W-2 or Form 1099)
- Estimated tax payments paid during the year
- Extension tax payments paid during the year
- Payments made during the year for taxes that arose in a previous year
- Mandatory Contributions to State Benefit Funds
Documents Needed to Support Your State Income Tax DeductionPayments of state and local income taxes can show up on a variety of different documents. Persons who pay state estimated taxes will want to keep copies of checks written. State taxes can also show up on various documents related to tax withholding. Keeping a record of all the checks that you write for state and local income taxes and forms that show any withholdings for city or state taxes will help you keep a tally of how much you can deduct. Here is a short list of documents that show how much state or local tax were paid during the year:
- Form W-2 (Wage and Tax Statement), which shows state income tax withholding in box 17; local income tax withholding is shown in box 19; and contributions to state benefit funds may be shown in box 19 or in box 14.
- Form W-2G (Certain Gambling Winnings), which may show state income tax withholding in box 15 and local income tax withholding in box 17.
- Form 1099-G (Certain Government Payments), which may show state income tax withholding in box 11.
- Form 1099-INT (Interest Income), which may show state income tax withholding in box 13.
- Form 1099-DIV (Dividends and Distributions), which may show state income tax withholding in box 14.
- Form 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.), which may show state income tax withholding in box 12 and local income tax withholding in box 15.
- Form 1099-MISC (Miscellaneous Income), which may show state income tax withholding in box 16.
- Bank statements with copies of canceled checks for estimated payments and after-the-fact payments of state tax.
- The portion of the previous year's state refund that was applied toward estimated taxes.
Year-End Tax Planning Using the State Income Tax DeductionThe state income tax deduction is useful in year-end tax planning, as taxpayers can choose to increase their state tax payments to cover any expected state liability that will occur for the year. For example, taxpayers can pay their fourth state estimated tax payment, normally due January 15, in December. This would boost a person's itemized deductions and can potentially reduce the federal tax liability for the year. Before accelerating their state income tax payments, taxpayers should check to see if increasing state tax payments at the end of the year will impact their federal return. Taxpayers who are impacted by the alternative minimum tax likely will find they receive little or no benefit on their federal return.
"Do not make prepayments if you expect to be subject to the alternative minimum tax, since state and local taxes are not deductible for AMT purposes," recommends the editors of J.K. Lasser's Your Income Tax (page 355).
Special Rules for SpousesMarried taxpayers filing jointly, can deduct all state and local income taxes that they paid in during the year, whether those tax payments were made separately or jointly.
Married taxpayers filing separately may only deduct state and local income taxes paid to each spouse individually on their 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 that you paid during the tax year." (Publication 17, chapter 22, section on state and local income taxes)
Special Rule for Spouses Filing Joint State and Separate Federal ReturnsMarried couples filing joint state and separate federal returns have special rules surrounding how they can deduct the state income taxes they paid for the year. In most cases each spouse can only deduct the amount of state taxes paid for the year that is proportionate to the percentage of income they generated, on an individual basis, compared to the joint total. In some cases, each spouse deducting the actual amount of individually paid state taxes, can be more advantages than just taking a deduction that is a percentage of how much you made out of the total amount of joint income. Each spouse can deduct the amount of state and local taxes that each of them actually paid during the year only if they live in a state that declares them jointly and individually liable for their state and local tax payments.
"If you and your spouse file joint state and local returns and separate federal returns,... 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.... 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." (Publication 17, chapter 22, section on state and local income taxes)
State Income Tax Deduction is an Adjustment Item for the Alternative Minimum TaxThe deduction for state and local income taxes is an adjustment item when calculating the alternative minimum tax (AMT). This means that state and local income taxes are deductible when calculating the regular federal income tax, but not deductible when calculating the AMT. Taxpayers who have AMT liabilities generally receive little or no benefit from deducting state and local income taxes. Taxpayers may consider deducting sales tax instead of the state income tax as an alternative strategy. This generally won't change a person's federal tax liability, as the sales tax deduction is also adjusted out by the AMT, but deducting the sales tax could make any state tax refunds non-taxable in the following year.
- Internal Revenue Code section 164
- Treasury Regulations sections 1.164-1, 1.164-2, 1.164-3, 1.164-4, 1.164-5, 1.164-6, 1.164-7, and 1.164-8.
- Publication 17, chapter 22, section on state and local income taxes
- Tax Topic 503, Deductible Taxes
- J.K. Lasser's Your Income Tax, chapter 16.1
- Schedule A (Form 1040) [pdf]
- Instructions for Schedule A