Deduction allowed on car's sales tax

Tax Talk

Tax Talk

April 17, 2007

Editor's note: This is the final installment of baltimoresun.com's weekly tax advice column featuring three experts from the Hunt Valley accounting firm SC&H Group. If you itemize, is it legal to deduct the taxes on a new car purchase? I believe it used to be, but is it now?

- Tony, Baltimore

Taxpayers who itemize must choose between deducting state income taxes paid or sales and use taxes paid during the tax year. The law allowing for the sales tax deduction expired but was reinstated late in 2006.

You get your potential sales tax deduction by tabulating actual sales taxes paid throughout the year or using the IRS tables provided in the instructions to Form 1040. In addition to the sales tax table amount, a taxpayer can add sales taxes paid on certain other purchases, including automobiles, boats, airplanes, homes or homebuilding materials, if the rate was the same as the general sales tax rate (which it is in Maryland).

Usually, taxpayers in states with low income tax rates or no income tax will benefit from the sales tax deduction option, though if you purchased a vehicle, boat or other item noted above, that option could prove more beneficial than deducting your income taxes.

Are the monthly premiums paid for Medicare insurance tax-deductible as medical expenses?

- Dave, Joppatowne

Medicare Part B premiums withheld from Social Security payments are eligible for this deduction, as are Part A premiums, if voluntarily enrolled and the taxpayer is not covered by Social Security. Medicare payroll taxes are not deductible. You can claim a deduction for medical and dental expenses only for the portion of total expenses that exceeds 7.5% of your adjusted gross income.

My minor daughter is an actress. She earned most of her income in theaters, traveling around the country and in Canada. While her earnings were significant, her expenses were also. Her mother has already filed and claimed her as a dependent. What forms do I need to use?

- James, Laurel

If your daughter earned more than $8,450 then she is required to file a federal income tax return. Her income from acting will be treated as business income if the primary purpose of her acting is for income or profit and she acts on a continuous and regular basis. If this is the case, she should report her income and expenses on Schedule C. If not, then the activity is considered a hobby and she should report the income on line 21, other income, of her form 1040. She may deduct all or part of her expenses. Please consult Federal Publication 535, which will assist you in determining what expenses you may deduct.

As a cautionary note, entertainers are often required to file nonresident state tax returns in the states in which they provided services. You may also need to file a Canadian income tax return. Canada and many states have relatively low thresholds for filing requirements compared to the $8,450 federal minimum. If the activity is significant, you should consider hiring a professional to assist you.

I took a small amount of money out of my retirement account in 2006 and paid the penalty and federal income tax. My tax preparer added that amount to my taxable income, when I thought that I already paid federal taxes. I should only have to pay state tax on that additional money, correct?

- Pam, Columbia

Distributions from retirement plans are subject to federal and Maryland income taxes. The withholding from the distribution may have helped to "cover" the taxes owed on that amount; however, the gross distribution should still be reported on both returns. There is a Maryland subtraction for a certain amount of pension income, depending upon certain variables like age, disability and Social Security earnings. Review Form 502 instructions for the pension exclusion rules.

In addition, there are several exceptions to the 10 percent penalty from retirement plans, even if you are under age 59 1/2 . Consider reviewing the instructions to Form 5329 to see if any of these exceptions apply to your situation.

Does the deductibility limit of $4,000 apply to both nondeductible IRAs and Roth IRAs as a whole, or separately? Also, do Roth IRAs require the filing of the 8606?

- Phil, Bel Air

The maximum annual contribution is the amount that may be contributed to both types of IRAs combined.

You may not contribute more than $4,000 total to both types of IRAs in one year, unless you are eligible for "catch up" contributions. Neither Roth nor nondeductible IRA contributions are tax-deductible.

You must file Form 8606 if any of the following circumstances are true:

You made a nondeductible contribution to an IRA for 2006, including a repayment of a qualified hurricane or reservist distribution.

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