Vehicle Sales Tax Deductions Explained
Many taxpayers are aware that you can deduct business use of a personal vehicle on your taxes. Often overlooked, however, are other vehicle tax deductions. The largest of these deductions is usually the vehicle sales tax deduction, and it can make a big dent in your tax liability. Here’s what you need to know about vehicles, sales tax, and the IRS rules.
What is the Vehicle Sales Tax Deduction?
The term “vehicle sales tax deduction” is a bit of a misnomer. There is no specific deduction for sales tax paid on a vehicle. There is, however, a deduction for any sales tax in general that you paid throughout the year. If you made a major purchase, such as a vehicle, it may behoove you to take this deduction.
This deduction isn’t automatic, however. The IRS forces you to choose between deducting your sales tax for the year or deducting any local and state income taxes you paid during the year. You can’t deduct both. Whichever one you choose, the IRS limits the deduction to $10,000. ($5,000 if you’re filing as single.) You’ll need to determine which deduction is most beneficial to you in the current tax year.
What is Deductible?
In short, any and all amounts you pay for sales tax during the year are deductible. This includes the tax on major purchases, including vehicles. Note that the IRS classifies cars, trucks, boats, airplanes, motor homes, and motorcycles all as vehicles. As such, you can claim the tax on any of these items when taking the so-called vehicle sales tax deduction.
The IRS limits the amount you can deduct, however, to the amount of sales tax you actually paid (up to the previously mentioned cap). In some states, for instance, the cost of your trade-in, if applicable, is deducted from the sale price of a new car before the income tax is calculated. In other states, such as California, Hawaii, Kentucky, Maryland, Michigan, Montana, and Virginia, you pay sales tax on the original purchase price of the car. Your trade-in value is not deducted when calculating the sales tax.
If you’re self-employed, please note that you may not be eligible for this deduction. If you purchased the car for your business, you may opt to deduct it from your Schedule C. If so, you can’t claim the deduction again on your Schedule A.
How to Claim the Vehicle Sales Tax Deduction?
In order to claim the sales tax for your vehicle and other purchases, you must itemize your deductions on the IRS Schedule A. Note, however, that even with a large vehicle purchase, your itemized deductions could still amount to less than the standard deduction. In that case, you’re better off skipping the sales tax deduction and simply taking the standard.
If you choose to claim the sales tax deduction, you may proceed in one of three ways. One is to simply use the IRS-provided sales tax table for your state. This is an IRS-generated estimate of what you paid for sales tax in your state throughout the year and makes taking the deduction easy. This method is simple, but it won’t account for the tax you paid for any unusually large purchases like your vehicle.
Another option is to calculate the amount of sales tax you did actually pay throughout the year. We’re going to be honest here — this involves adding up the tax on literally everything you bought throughout the year. It’s tedious and time-consuming, and it will likely be inaccurate anyway. Seriously, who keeps EVERY receipt?
This leads us to choice number three. Many people deduct the amount of sales tax they paid for their vehicles and other big-ticket items and ignore their everyday purchases. This allows you to take the sales/vehicle deduction if it benefits you without making you tear your hair out amid a pile of old receipts.
Can You Deduct New Car Sales Tax If It’s Financed?
Alas! We have a tax question that has a simple answer: Yes. You can deduct the sale tax you pay on a vehicle purchase even if you finance the vehicle. In fact, the IRS requires that you deduct the sales tax for your new vehicle in the year you purchased it, regardless of how your financing is set up. You are not allowed to deduct it little by little over the life of the loan.
If You Buy a Car in Another State, Where Do You Pay Sales Tax?
This is a good question, and the answer is that it depends. There are approximately 10,000 sales tax jurisdictions in the United States, and they all work a little differently.
As a general rule, sales tax on a car or other vehicle is charged at the tax rate where you make the purchase. The money collected, however, is sent to the relevant tax-collecting agency in your home state. If the tax you paid was less than the tax charged in your state, you may need to cover the shortfall before you can register your vehicle.
For example, the state of Pennsylvania charges a 6 percent sales tax rate. Ohio, however, charges only 5.75 percent sales tax. Most likely, if you buy a car in Ohio, the dealer will collect 5.75 percent of the purchase in sales tax and then send it to Pennsylvania. Pennsylvania will then ask you to pay the remaining 0.25 percent to make the tax 6 percent.
It’s important to research this before buying out of state because it doesn’t always work as described above. Some states will expect you to pay sales tax where you buy the vehicle rather than where you live.
Using the Deduction Calculator
If you’re still feeling a little iffy on the sales tax deduction but want to do your taxes yourself, consider using the IRS sales tax calculator, found here.
Before getting started, gather your income statements such as W-2’s and 1099s along with the receipt for your vehicle and other large purchases. You’ll also need to know your zip code, filing status, and how many dependents you’ll be claiming. Once you’ve collected the relevant information, simply answer the questions the calculator asks you. It will guide you through the process and calculate the deduction for you.
Depreciation and Section 179 Deductions
Although it admittedly has nothing to do with the vehicle sales tax, we would be remiss in our duties if we didn’t remind you of other potentially large vehicle tax deductions. If you use your car for business most of the time, you can claim a depreciation deduction. Usually, this deduction is taken a little at a time each year as the car’s value depreciates.
You may also have the option of taking a Section 179 for vehicles. To encourage businesses to invest in equipment, Section 179 of the IRS code allow you to skip depreciation every year and instead deduct the purchase price of the vehicle in its entirety the year you put it into service. This, in essence, allows businesses to purchase what are essentially tax deductible vehicles.
Note the phrase “the year you put it in service.” It doesn’t matter how you put it in service. Let’s say, for example, you buy a new car in 2020 for personal use. In 2021, the car you use for business breaks down. You start using your personal car for business use and buy yourself a new car for personal use. You can’t deduct the car from your taxes in 2021 because the car was in service for a year before that. If you were going to claim the car, you needed to do it in 2020 when it was first used.
Should You Consult a CPA?
Make sure you understand the limits of the Section 179 deduction, however. The IRS has special rules for sport utility vehicles and a few others, so know the rules before you buy if you plan on using Section 179. Always consult a CPA first rather than trusting a car dealer to understand the ins and outs of the tax laws for vehicles. Some may be quite knowledgeable, but others can get you into hot water with the IRS.
Dong your taxes is a lot more fun when you’re finding lots of deductions than it is when you have to pay out. The CPAs at Picnic Tax enjoy helping taxpayers reduce their tax liability, and they’re good at what they do. Get in touch with us today or any day that you have questions about deducting your vehicle or other tax matters. We’ll help you make sure you don’t miss a penny in beneficial vehicle deductions.