What taxes are deductible on a federal income tax return?

There are several kinds of taxes that are deductible, but not all deductions are available for all taxpayers. Because of major tax reform enacted in December 2017, commonly referred to as the Tax Cuts and Jobs Act in 2017, the ability to itemize deductions to reduce taxable income was severely curtailed, as were tax credits and other deductions and significant changes in the impact of the AMT.

(NOTE: With the latest tax law changes, the federal tax form, Form 1040, underwent a significant set of design changes and is a lot more basic than it used to be. Gone are forms 1040A (the “short form”) and 1040EZ (the form for filers who have no dependents) and instead Form 1040 and related forms and schedules are now built as a more modular set of forms. There are also 6 new numbered schedules or forms to be filled in if applicable to your circumstance.)

Self-employment taxes are deductible for everyone who is self employed.  Beginning in 2018, they are deducted on Schedule 1 of Form 1040.

State and local income taxes (or if you elect instead, sales tax), real estate taxes and personal property taxes are deductible if you are able to itemize, on Schedule A.  (Property taxes held in an escrow account are not deductible until actually paid by the escrow company to the taxing authority.) Or, if it works better for your tax situation, you have the option to deduct sales tax in lieu of state and local income taxes.  The main reason for this option is to allow fair treatment for taxpayers located in states that do not have state income tax.

2017 tax law changes: Beginning in 2018 through 2025, on Schedule A, the combined, total deduction for state, local, and property taxes is limited to $10,000 ($5,000 if married filing separately).  Any state and local taxes paid above this amount cannot be deducted.

The deduction for foreign real property taxes is totally gone (unless paid in carrying on a business or trade).

Foreign income taxes can be deductible but there is also a credit available for foreign income taxes and that normally produces a better result than a deduction.  That is something that should be discussed with your tax consultant.

For more information on deductibility of taxes, see IRS Publication 17.

Case Studies: Deductible Taxes on Federal Income Tax Returns

Case Study 1: Self-Employment Taxes

Maria is a freelance graphic designer. She operates as a sole proprietor and files her federal income tax return using Form 1040. In 2022, Maria earned $80,000 in self-employment income. As a self-employed individual, she is responsible for both the employer and employee portions of Social Security and Medicare taxes.

For the tax year, Maria paid self-employment taxes totaling $11,360. She can deduct the full amount of self-employment taxes on Schedule 1 of Form 1040, reducing her taxable income.

Case Study 2: State and Local Taxes

John and Lisa are homeowners in New York state. They itemize their deductions on Schedule A of Form 1040. In 2022, they paid $12,000 in state income taxes and $8,000 in real estate taxes. Since the total deduction for state, local, and property taxes is limited to $10,000 under the 2017 tax reform, John and Lisa can only deduct $10,000 on Schedule A. The remaining $2,000 cannot be deducted on their federal income tax return.

Case Study 3: Sales Tax Deduction

Sarah recently relocated to Texas, a state with no individual income tax. As a result, she has the option to deduct sales tax on Schedule A of Form 1040 instead. In 2022, Sarah purchased a new car for $25,000 and paid $1,750 in sales tax. Since she opted to deduct sales tax instead of state income tax, Sarah can include the $1,750 as an itemized deduction on her federal income tax return.

Case Study 4: Foreign Income Taxes

David, a U.S. citizen, works as an expatriate in Germany. In 2022, he earned a salary of €70,000 and paid €5,000 in German income taxes. While foreign income taxes are deductible, David also qualifies for the Foreign Tax Credit.

After consulting with a tax advisor, he determines that claiming the Foreign Tax Credit instead of a deduction results in a more favorable outcome. By utilizing the credit, David can offset his U.S. tax liability dollar-for-dollar, potentially reducing his overall tax burden.