Congress granted a new deduction for 2004: the sales tax deduction. Taxpayers can now deduct income tax or sales tax–not both. Since Texas has no income tax, the sales tax deduction finally puts us on a level playing field with most states. This deduction only lasts through 2005, so I hope Congress extends it!
My wife went through all of our 2004 receipts and split out each transaction in Microsoft Money so that they had sales tax as a separate line item. Here’s what I mean by “split out”: suppose you spent $4.32 at a restaurant for a meal. Normally you would just enter $4.32 and categorize it all under Food : Dining Out (this syntax means that Dining Out is a subcategory of the Food category). Now that the sales tax is deductible, it needs to be tracked separately. In splitting the transaction, the $4.32 has a $3.99 Food : Dining Out component and a $0.33 Taxes : Sales Tax component.
This splitting screws up our budgeting. A while back I established a monthly spending guideline in Money’s Budget feature for the Food : Dining Out category. Before 2004, the entire $4.32 would go into the Food : Dining Out category. During 2004, with the sales taxes split out, only $3.99 went into that category. Now it looks like we are doing better with our budget than reality.
After going though all of our receipts–we probably lost only about 2% of all receipts–we had Money tell us how much sales tax we spent in 2004.
The IRS allows you to deduct either your actual sales tax expenses or calculate an estimated annual sales tax expense based on your income. You still get to add to the IRS estimate sales taxes on major purchases such as vehicles.
Surprisingly, the IRS estimate was around a third higher than my actual sales tax spending! I figure that either 1. the IRS is generous with this estimate or 2. the IRS figures that the average taxpayer spends far more of his income on taxable goods and services than me.
Given this revelation, I am no longer splitting out sales taxes on each transaction. There is no way I could beat the IRS sales tax estimate unless I radically reduced my savings and non-taxable spending (e.g., charity, mortgage).