Congress Restores State Sales Tax Deduction

Taxpayers in seven states will get a temporary break on their federal income taxes.

A giant corporate tax bill that Congress approved over the Columbus Day weekend includes a provision that will allow taxpayers in states without income taxes to deduct sales taxes instead from their federal taxable income in 2004 and 2005. Under current law, state income tax already can be deducted.

President Bush is expected to sign the bill (HR 4520), which restores a tax break that was eliminated in 1986. The deduction is expected to lower federal tax bills for some citizens in Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming for two years.

The deduction would expire after 2005, but some budget experts speculate that, like other tax cuts, this one would be routinely extended.

"To restore, if only temporarily, the deductibility of state and local sales taxes is to restore fairness to the federal tax system," Idaho state Rep. Maxine Bell, chairwoman of the National Conference of State Legislatures' budget committee wrote in an Oct. 5 letter to Congress in support of the measure.

The sales tax provision has little to do with the overall bill, which would cut tax rates for U.S. manufacturers while it eliminates export subsidies that have been ruled illegal by the World Trade Organization.

Technically, the measure would allow taxpayers in all states to choose between deducting state sales taxes or state income taxes on their federal returns. Because a person typically pays more in income taxes than sales taxes, taxpayers in states without income taxes are the ones who would benefit under the proposal.

The exact amount a taxpayer will be able to deduct will be determined by a formula from the Internal Revenue Service.

Nine states impose no income tax, but Alaska and New Hampshire also don't have sales taxes so are unaffected.

Advocates of reinstating a sales tax deduction say the current federal tax code is unfair to states without income taxes because it allows taxpayers in 41 states to reduce their federal tax burden by deducting state and local income taxes. The best way to remove this inequity, supporters say, is to allow states without income taxes to deduct state and local sales tax.

The Center on Budget and Policy Priorities, a group that studies policies that affect the poor, said the sales tax deduction proposal largely would help only taxpayers who itemize their federal tax returns. This group tends to be financially well-off, the center said. The center estimates that seven out of every 10 residents of Texas and Tennessee would save nothing under the bill.

The Seattle Post-Intelligencer reported that tax analysts estimate about half of Washington state taxpayers could benefit, and supporters of the measure said the typical savings would be $300 to $500.