The sales tax deduction: How it works, how to calculate it

This post has been updated. It was originally published on July 10, 2023.

Savvy business folk take advantage of tax deductions to lessen their tax burden, and there are a slew of tax deductions for the taking. But not all tax deductions apply to every business scenario, and some deductions may not be what they seem. The sales tax deduction is a case in point.

To help you determine whether and to what extent you can benefit from a state and local general sales tax deduction, this post will answer the following questions:

• What is a sales tax deduction?
• How does the federal income tax deduction for state and local taxes work?
• How is the sales tax deduction calculated?
• What is the standard deduction?
• Can businesses claim a sales tax deduction?
• What are other types of sales tax deductions?
• What is a sales tax exclusion?
• Sales tax deduction FAQ

A deduction is something that is or may be subtracted. A sales tax deduction is an amount of sales tax subtracted from a tax bill. 

The sales tax deduction is part of the state and local tax (SALT) deduction offered by the federal government and administered by the IRS. United States taxpayers are entitled to deduct a certain amount of state and local sales and use taxes or state and local income taxes from their taxable income, thereby lowering the amount of federal income taxes they owe.

States also offer sales tax deductions, though not in the same way as the federal government. We’ll cover state sales tax deductions in more depth below.

U.S. taxpayers can lower their individual federal income tax bill by claiming the state and local tax deduction offered by the federal government. The deduction for state and local income, property, and sales taxes for an individual is currently capped at $10,000 ($5,000 if married and filing separately) due to the 2017 Tax Cuts and Jobs Act (TCJA). Prior to the TCJA, there was no limit on the state and local tax deduction. 

The $10,000 SALT deduction cap is set to expire after 2025. 

Taxpayers can deduct property tax plus state and local income taxes or state and local general sales taxes, but not property tax plus state income tax and sales tax.

For example, if you paid $7,000 in state and local sales taxes in 2024 and also $7,000 in state and local income taxes in 2024, you could claim a $7,000 sales tax deduction or a $7,000 income tax deduction. Either would lower your 2024 taxable income, for federal income tax purposes, by $7,000. However, you couldn’t combine the sales tax and state and local income tax deduction to claim a $14,000 SALT deduction.

Typically, you can only deduct state and local general sales and use taxes paid at the general sales tax rate, but there are some exceptions to that rule. 

For example, if your state taxes food at a reduced rate, like Alabama and Illinois, you’d be entitled to deduct the general sales tax rate rather than the reduced rate for your food purchases.

You usually can’t deduct any tax paid at a higher rate than the general rate; in such cases, you’re only permitted to deduct the amount of tax you would have paid at the general sales tax rate. 

An example of a higher-than-normal rate is the 7.75% luxury tax Connecticut levies on luxury items such as jewelry with a sales price of more than $5,000 and apparel and accessories priced more than $1,000; this is greater than Connecticut’s 6.35% general sales tax rate.

There are basically two ways to calculate how much state and local sales tax you can deduct for individual income tax purposes: 

• Itemize your sales tax expenses on the Schedule A
• Estimate the tax paid using the IRS optional sales tax tables and/or the IRS sales tax deduction calculator

It may make sense to use both methods, estimating most sales and use taxes paid but listing large purchases like motor vehicles on the itemized deductions. The IRS allows this. 

Whether you itemize some or all expenses, if you claim the sales tax deduction, be sure to keep receipts for all purchases for proof of tax paid.

There’s also a third option: If you don’t want to itemize or estimate the sales tax paid, you can take the standard deduction offered by the federal government. The IRS typically recommends you choose whichever option will give you the greatest tax savings.

The standard deduction for individual income tax isn’t tied to the state and local sales tax, income tax, or property taxes you paid. It’s based on your filing status, and the allowable deduction usually changes each year. 

Standard deduction amounts for tax year 2024, due April 2025, are:

• $14,600 for a single person or one who is married and filing separately
• $21,900 for a head of household
• $29,200 for a married couple filing jointly

Standard deduction amounts for tax year 2025, due April 2026, are:

• $15,000 for a single person or one who is married and filing separately
• $22,500 for a head of household
• $30,000 for a married couple filing jointly

Many taxpayers opt to take the standard deduction because it’s more generous than the state and local tax deduction, which is currently capped at $10,000. That said, taking the standard deduction may prohibit taxpayers from benefitting from certain other tax breaks. If you want to deduct your mortgage interest, you’ll need to itemize deductions. 

Furthermore, not everyone is eligible for the standard deduction. For instance, you can’t claim the standard deduction if you’re a married individual filing separately and your spouse itemizes deductions. Estates or trusts, common trust funds, or partnerships also aren’t eligible.

Consult with a trusted tax advisor if you’re not sure which route would be best for you.

Businesses can deduct sales tax on eligible business expenses. 

IRS Publication 535 explains: “Any sales tax you pay on a service for your business, or on the purchase or use of property in your business is treated as part of the cost of the service or property. If the service or the cost or use of the property is a deductible business expense, you can deduct the tax as part of that service or cost. If the property is merchandise bought for resale, the sales tax is part of the cost of the merchandise. If the property is depreciable, add the sales tax to the basis for depreciation.”

On the other hand, you cannot deduct state and local sales taxes imposed on a buyer that you’re required to collect and remit to your state or local tax authorities. Furthermore, such taxes should be excluded from your gross receipts or sales.

There’s no cap on SALT deductions for C corporations, which pay taxes at the entity level, but the $10,000 SALT limit applies to business owners who report their business earnings as pass-through income.

Even so, approximately 35 states allow pass-through businesses to pay taxes at the entity level (like C corporations) rather than on the individual income tax returns of the owners or shareholders. If a pass-through entity chooses this option for a given tax year, all owners or shareholders are bound by it.

The SALT deduction offered by the federal government isn’t the only sales tax deduction available to businesses. States generally allow a variety of tax deductions as well. 

“In the sales tax world, the word ‘deduction’ is a return-specific word,” explains Scott Peterson, VP of Government Relations at Avalara. “No one has a deduction unless they’re deducting something from a tax return. With respect to sales tax, ‘tax deduction’ means nothing outside of a tax return.”

Businesses typically deduct exempt transactions: sales to exempt entities or sales of exempt products or services.

For example, Washington state offers a retail sales tax deduction for exempt food sales, feminine hygiene products, and trade-in allowances. It also allows marketplace sellers to claim a retail sales tax deduction for sales where a marketplace facilitator collects and pays sales tax on their behalf. You can learn a lot about a state from its list of deductions.

Deductions work a little differently in Arizona, Hawaii, and New Mexico, because these states don’t have a traditional sales tax. Arizona has a transaction privilege tax (TPT). Hawaii has a general excise tax (GET), and New Mexico has a gross receipts tax (GRT). Still, the general concept remains the same. 

Moreover, taxing authorities sometimes provide a sales tax deduction to benefit specific types of businesses or in response to certain circumstances. Colorado created a temporary restaurant and bar special sales tax deduction to help businesses badly affected by the COVID-19 pandemic. Businesses that qualified for this unique sales tax deduction were allowed to retain and spend the state sales tax collected during a three-month period.

A sales tax exclusion is similar to a statutory sales tax exemption in that no tax applies to the transaction. The difference is who has the burden of proof.

With a sales tax exclusion, the state has the burden of proving the taxpayer isn’t entitled to the exclusion. With a sales tax exemption, the burden of proof falls on the taxpayer.

A sales tax deduction explains why the sales tax a business remits matches taxable sales, not gross sales, when the two numbers aren’t the same. “For sales tax purposes,” explains Peterson, “a deduction is how someone officially represents an exemption in the sales tax law.”

A sales tax exemption typically occurs for one of three reasons: 

1. The product or service is statutorily exempt from sales tax (e.g., diapers are exempt from Florida sales tax)
2. The buyer qualifies for an exemption (e.g., federal and Texas government agencies are automatically exempt from Texas sales tax)
3. The use is exempt (e.g., items purchased for resale are exempt from Illinois sales tax)

There tend to be very few deductions at the state level but lots of exemptions. All exemptions must be deducted from gross receipts on a sales tax return.

Exemptions vary from state to state. Unless a transaction is statutorily exempt from sales tax, like the sale of diapers in Florida, the buyer typically needs to provide the seller with a valid exemption certificate or resale certificate as proof they’re not required to pay the sales tax. 

For income tax purposes, it’s generally in your best interest to take advantage of the tax deductions available to you. For sales tax, it would be a mistake to not deduct your exempt sales from your sales tax return.

Business records need to account for what you’ve spent and what you’ve sold, regardless of what type of deduction you’re claiming.

That’s up to you. If you’re not a tax expert yourself and you aren’t sure where to start, an accounting professional can help you find and understand the tax deductions available to you. Many firms, even small accounting practices, now offer tax advisory services and tax compliance services.

Avalara helps thousands of businesses with sales tax compliance. Visit our website to learn more.