Are Tax Payments Deductible? Here’s What Qualifies
Navigate the complexities of tax deductibility. Understand which tax payments can reduce your taxable income and what doesn't qualify.
Tax deductions can reduce your taxable income, ultimately lowering the amount of income taxes you owe. Not all tax payments are deductible, and the rules vary depending on the type of tax and whether it’s for personal or business purposes. Understanding which tax payments qualify for a deduction can help individuals and businesses manage their tax liability more effectively.
Understanding Tax Deductibility
A tax deduction is an expense that can be subtracted from your gross income, which then reduces your taxable income. This differs from a tax credit, which directly reduces the amount of tax you owe. While both deductions and credits lower your tax liability, a credit generally provides a more direct and greater tax benefit.
Taxpayers typically choose between taking a standard deduction or itemizing their deductions. The standard deduction is a fixed amount set by the IRS, varying by filing status and adjusted for inflation. Since the Tax Cuts and Jobs Act of 2017 significantly increased standard deduction amounts, most taxpayers find opting for the standard deduction simpler and more beneficial. However, if your total eligible itemized deductions exceed your standard deduction amount, itemizing can lead to greater tax savings.
Taxes Deductible as Itemized Deductions
Certain tax payments are deductible if you itemize on Schedule A of Form 1040. State and local taxes (SALT) are common qualifying taxes, including income, general sales, and real estate taxes.
A significant limitation for individual taxpayers is the federal cap on the SALT deduction. For tax years 2018 through 2024, this deduction was limited to $10,000 per household ($5,000 if married filing separately). Starting in 2025, this cap is set to increase to $40,000 ($20,000 if married filing separately). Real estate taxes are generally deductible if assessed uniformly for general community or governmental purposes and based on the property’s value.
Personal property taxes are also deductible if based on the value of the property, such as a car or boat, and charged yearly. These also fall under the overall SALT deduction limit.
Taxes Deductible as Business Expenses
Businesses and self-employed individuals can deduct various taxes as ordinary and necessary business expenses. This reduces their taxable business income. Employers’ share of Social Security and Medicare (FICA) taxes is deductible. Federal unemployment taxes (FUTA) paid by employers are also deductible business expenses.
State and local taxes paid by a business or self-employed individual are often deductible if directly related to the business operation. This includes state and local income taxes, franchise taxes, and property taxes on business assets. These deductions are taken on the business’s tax return, such as Schedule C for sole proprietors, and are separate from personal itemized deductions.
Self-employed individuals are responsible for both employer and employee portions of Social Security and Medicare taxes. They can deduct one-half of their self-employment tax as an adjustment to income on Form 1040, reducing their adjusted gross income (AGI) and income tax liability. Certain excise taxes are also deductible if incurred as ordinary and necessary business expenses.
Taxes That Are Not Deductible
Many common taxes are not deductible on federal income tax returns. Federal income taxes paid, whether through withholding or estimated payments, are not deductible. Similarly, Social Security and Medicare (FICA) taxes withheld from an employee’s wages are not deductible.
Federal estate and gift taxes are generally not deductible. Excise taxes paid for personal use, such as those on gasoline, tires, or telephone services, are not deductible. If you choose to deduct state and local income taxes as part of your SALT deduction, you cannot also deduct sales taxes on specific purchases.
If a taxpayer claims a foreign tax credit for foreign income taxes paid, those same foreign taxes cannot also be taken as a deduction. Other non-deductible charges include homeowner’s association fees, trash collection fees, and homeowner’s insurance premiums.
Foreign Tax Credit
While not a deduction, the foreign tax credit is a significant mechanism for reducing U.S. tax liability related to taxes paid to foreign countries. This credit directly reduces your U.S. tax bill, dollar for dollar, for income taxes paid or accrued to a foreign country. Its purpose is to prevent double taxation on income earned abroad.
Choosing between taking a foreign tax credit or deducting foreign taxes as an itemized deduction is generally an option for taxpayers with foreign income. Claiming the foreign tax credit is more advantageous than taking a deduction because it provides a direct reduction of tax owed. A deduction only reduces taxable income, which provides a benefit based on your marginal tax rate.