California Options for Filing State Income Tax

Late in 2004, Congress legislated a change to the tax code that gave taxpayers who itemize deductions on their federal returns a choice of how they could handle their state assessed taxes. Tax Bill S. 1637 gave taxpayers the choice between two options, allowing whichever was the most advantageous to the filer. The taxpayer could either continue with the standard method of writing off the state assessed taxes they paid that year or could claim the actual sales taxes they paid that year instead.

The change came so late in the year, that few people were prepared to comply for tax year 2004. In order to take advantage of the sales tax option, filers must retain all their receipts from all taxed purchases. That's a lot of paper. The law was fully implemented in tax year 2005 and now that tax year 2006 is upon us, we can see how the bill impacts each state.

In California, for instance, the bill provides virtually no benefits to average individual taxpayers. This is because California has the third highest state income tax rate in the nation in addition to a very high sales tax. Choosing one over the other may be the lesser of two evils. A possible scenario for a Californian to benefit from the option would be a year of relatively low income earnings and relatively high end purchases, such as a car, computer equipment or electronics.

Speaking of cars, the new tax law impacts the rules of donating cars. Under the prior law, you could deduct the fair market value of a vehicle donated to a recognized charity. Under the current new law, you can deduct only the amount the charity receives when it sells the vehicle, and only if that amount exceeds $500.

It now appears that the people getting the most from this legislation are high income residents of states with a sales tax but no income tax. That would be such states as Florida, Nevada, Washington, Wyoming, Tennessee and South Dakota. It provides virtually no benefits to individual taxpayers in California, for instance, due to California's high double whammy of income and sales taxes.

The cosmetic name given to Tax Bill S. 1637 was The American Jobs Creation Act of 2004. In truth, the tax bill had about as much to do with creating American jobs as your grandmother's homemade rheumatism remedy. But legislators being legislators, that was the feel-good title given to this political tweaking of the tax code.

This tax bill had the typical astounding riders attached to it (in this case, a tax break for makers of fishing equipment in former House Speaker Dennis Hastert's Illinois district). But its purported objective was to address the disparity of tax paid by residents of states with and without state income and sales taxes. The main backers of the tax bill were Congressional members from states with no income tax requirements. Residents of states with no income tax felt it wasn't equitable that they were unable to claim a state tax deduction.

In order for residents of states like California to get the most advantage from this tax bill, it might be necessary to tease out the tax percentages that may be incorporated into large scale charges, such as home remodeling, building costs, materials assessments and appliances. It might even be advisable to plan big expenditures in the same year, rather than spread out over time, if such spending is at all possible. It is worth noting that the filer is not locked into either the state income tax method of deduction or the state sales tax method of deduction, once the option is chosen. The taxpayer can toggle back and forth from year to year, depending upon which method is most advantageous. Be sure to run the numbers with your tax professional or through your tax preparation software.