By Martin Wolk Executive business editor
updated 10/15/2004 1:57:12 PM ET 2004-10-15T17:57:12

A tax bill passed by Congress this week includes a big break for middle-class taxpayers in Florida, Nevada, Texas and four other states with no income tax.

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The $5 billion provision is included in a grab-bag tax bill that was given final approval by the Senate Monday but still needs to be signed into law by President Bush, which is not yet certain.

If the law is enacted, taxpayers who itemize will be able to take a deduction for sales tax paid in 2004 and 2005 instead of taking a deduction for state income tax.

For residents of most states, the bill will have little impact because taxpayers who itemize usually pay more in state income taxes than in sales taxes. But taxpayers in the seven states that have sales tax but no income tax, including Washington, Tennessee, Wyoming and South Dakota, could save hundreds or even thousands of dollars a year.

Pete Sepp, spokesman of the National Taxpayers Union, called the new tax deduction one of a “handful of truly outstanding features” of a tax bill that by all accounts was stuffed with pork.

“States that have had the foresight not to burden their citizens with income taxes at their own level shouldn’t be penalized by not having a deduction at the federal level,” Sepp said.

Middle-income homeowners would be most likely to benefit from the measure because they are most likely to itemize their deductions to take advantage of tax breaks for mortgage interest and property taxes. The extra deduction for sales tax would be worth about $300 to $500 year for the typical itemizer, according to proponents.

And don’t worry about saving up hundreds of receipts to prove how much you paid in sales tax on clothing, electronics, appliances, meals and other everyday purchases. Taxpayers will be able to estimate their sales tax deduction by using Internal Revenue Service tables that will adjust for income, family size and local tax rates.

Consumers who make a big-ticket purchase of a car or boat, will be able to deduct the sales tax paid for the item in addition to the regular estimated amount, a feature that might even benefit taxpayers who currently deduct state income taxes.

The measure does nothing to help the millions of low-income Americans who do not earn enough to pay federal income tax, nor does it help the two-thirds of taxpayers who do not itemize. But one of the lead House sponsors of the measure said the deduction will bring a measure of equity to taxpayers who do itemize and should be a boost to local economies in the affected states.

“In our state alone our taxpayers were losing collectively $500 million to the federal government that should have been in their pockets,” said Rep. Brian Baird, D-Wash. “Whatever income bracket you’re in, having $500 million circulating in your state rather than going to taxes is going to help you.”

The new allowance restores a deduction that was available to taxpayers prior to the 1986 tax reform. Back then, taxpayers were allowed to deduct both sales tax and state income tax under the theory that the federal government should not be able to tax income that has already been paid in taxes.

Baird said he has been working to restore the sales tax deduction since he was elected to Congress in 1998, but the plan was too expensive until he hit on the idea of offering taxpayers a choice between deducting sales tax or income tax. “No other states lose anything, but it does put those states that (only) have sales tax on an equal footing with those that have an income tax,” he said.

A bipartisan congressional group then looked to attach the measure to a “must-pass” bill, which turned out to be the $136 billion corporate tax bill, optimistically titled the American Jobs Creation Act of 2004.

Passage of the bill was considered urgent because it addresses a tax break that has been declared illegal by the World Trade Organization. Punitive European Union tariffs on U.S. exports are scheduled to rise unless the tax break is eliminated.

And that is why many observers expect Bush to sign the bill into law despite criticism — even by Treasury Secretary John Snow — of its many special interest tax breaks.

While middle-class taxpayers can benefit from the new provision on sales taxes, lower-income and upper-income earners will be mostly shut out. Lower-income earners generally take the standard deduction because they don’t have enough assets or income to make itemizing worthwhile.

And itemizing is gradually phased out for people who earn more than $143,000 a year. “We feel the people who are going to benefit most consistently are those earning $200,000 or less,” said Alan Kirzner, a partner with Goldstein Schechter Price Lucas Horwitz & Co., an accounting firm in Coral Gables, Fla.

He also said the new provision opens the door for new tax strategies, like bundling major purchases into a single tax year for itemizing.

The sales tax provision is scheduled to “sunset” at the end of 2005, but proponents already are at work trying to extend it permanently, said Baird.

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