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Sales Tax: What It Is and How to Deduct It

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Sales Tax: What It Is and How to Deduct It?

There’s nothing like saving for your dream car, laptop or iPhone only to be surprised by a much higher bill at checkout, all thanks to state sales tax. Taxes are a source of income for the government and fund things like schools, roads, security and national debt. For US states, sales tax is usually the primary source of funding. There’s no denying that paying taxes is a task no one enjoys, but there’s some good news about sales tax. You can take a sales tax deduction on your tax return and save some of your hard-earned cash. Key Takeaways

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Table of contents

What is sales tax?...Read more

What does sales tax fund?...Read more

Can I deduct sales tax?...Read more

Are state taxes deductible?...Read more

Schedule C for taxes...Read more

What’s the difference between sales tax and VAT?...Read more

How to avoid sales tax?...Read more

What is sales tax?

Sales tax is a tax imposed by the government when citizens purchase goods or services. It is collected by the payment processing entity or a third party, such as Paypal or Venmo. Sales tax is considered a pass-through tax system, meaning when the tax is collected from a merchant, instead of keeping it, they pass it on to the state along with a sales tax return. Sales tax rates vary by state. For example, Hawaii’s sales tax rate is 4.44%, but California’s sales tax rate is 7.25%. All but five states have some sort of sales tax in place. The states without a sales tax are Delaware, Oregon, New Hampshire, Alaska and Montana. Local counties, districts and cities can also collect sales tax. This means an extra 1-2% on top of the state sales tax. This tax goes towards funding things like local schools, roads and parks. For example, in Philadelphia, you’ll be charged a tax of 1.5 cents per ounce for sugary drinks like soda and other sweetened beverages. But the same soda won’t have the city tax if bought outside city limits.

What does sales tax fund?

Since sales tax is administered at a state level, any collected sales tax is used to benefit the state. Most of the money collected goes into a General Fund, the main source of funds for funding the state’s operations.

Image showing a list of important public services and funding areas such as schools, police and fire departments, parks, healthcare, transportation, and taxes. No mention of self-employment or 1099.

The specific programs funded by the General Fund vary by state. For example, in Pennsylvania, state legislators voted on spending for the General Fund, which determines how much money will be allotted for each fund category.

Can I deduct sales tax?

You might be wondering, is sales tax deductible? Well, you could be eligible to deduct sales tax if you:

Make big renovations or purchases throughout the year
Live in a state without sales tax
Can save more by itemizing deductions instead of taking the standard deduction

When it comes to the general sales tax deduction, the IRS has certain criteria in place. You can deduct state and local sales tax or state and local income tax paid in the previous tax year but you can’t deduct both at the same time. The way to deduct sales tax is by itemizing your deductions. Usually, taking the income deduction is the better way to save money on your tax return since your income taxes are higher. But if you make many big purchases during the year, your sales tax might exceed your income tax. You’ll need to gather all your receipts or proof of sales, including the sales tax. On Schedule A, you’ll find a table with the sales tax rates for every state. Then you’ll need to factor in your tax bracket to see how much sales tax you can deduct. It might be helpful to use a sales tax IRS calculator to help calculate how much sales tax you can deduct. You can choose to itemize your deductions when paying income tax and also itemize your business expenses to lower self-employment taxes.

Are state taxes deductible?

Simply put, yes, you can take the state tax deduction. However, the Tax Cuts and Jobs Act (TCJA) changed the federal tax deduction for state sales tax requirements, and taxpayers are only allowed to deduct up to $10,000 of state sales tax or income tax. For example, if you’re a professional musician, and the amount of self-employed income you earned requires you to pay $12,000 in income taxes and $4,000 in state sales tax, you can only deduct $10,000 from the $14,000 total tax amount.

Schedule C for taxes

On the Schedule C tax form, you will list the amount of sales tax you paid throughout the tax year. Schedule C is used for any deductions you might take as a freelancer, independent contractor, self employed person or gig worker. Some Schedule C deductions include things like:

Vehicle mileage
Work clothes or uniforms
Education expenses
Business meals
Business travel

What’s the difference between sales tax and VAT?

Both sales tax and VAT (value-added tax) are consumer taxes, meaning they have to be paid when you purchase something to be used. But one key difference is sales tax is added to the final price, whereas VAT is already included in the price.

Comparison of Sales Tax and VAT. Sales tax paid by final consumers, while VAT is included in prices. Resellers exempt from sales tax, pay tax to vendor. No relevance to self employed, 1099, freelancer or taxes.

How to avoid sales tax?

Some people are adamant about avoiding sales taxes, even if you can take a sales tax deduction on your taxes. If you think you might fall into this category, there are some ways you can actually avoid paying it. But trying to avoid sales tax does come with a risk of penalties or interest charged if the IRS finds out. States without sales tax One easy way to avoid sales tax is to make purchases in a state without sales tax. For example, people living in Pennsylvania travel to Delaware to buy big-ticket items like laptops, sofas, cell phones and TVs to avoid sales tax. But this option might not be possible if you don’t live near one of the five states without sales tax. Buy online Internet merchants don’t have to collect sales tax if they don’t have a physical presence in the state. These remote sales cause states to miss out on a lot of uncollected tax. Small merchants and sellers on eBay are not allowed to collect sales tax. States with special exemptions Some states have exemptions in place on certain items. You can reduce sales tax when you buy the products in those states. There's no sales tax on chocolate in California, Vermont, Ohio, Pennsylvania and Arizona. In Connecticut, you won’t have to pay sales tax on diapers. In South Carolina and Virginia, there’s no sales tax on digital products.

Adjust For Inflations

The IRS has released its yearly inflation adjustment for the 2023 tax year, aimed to give US taxpayers relief from rising inflation.