When you prepare your federal tax return, keep itemized deductions in mind. If the deductions you can take exceed your standard deduction amount, you're better off itemizing on Schedule A. This results in lower taxable income and less tax owed to the Internal Revenue Service. The agency allows you to deduct taxes you pay to your state, as long as you itemize.
If you want to calculate itemized deductions, you must use Form 1040, Schedule A. You can include on this form any state taxes that were withheld from your paycheck and any estimated taxes you paid in the course of the year. On line 5, you can deduct either income or sales taxes. On line 6, you deduct real estate taxes. On line 7, you deduct personal property taxes. Line 8 is for other taxes you may have paid to your state, county or city.
A few states levy a tax for public disability insurance programs. California, for example, requires employers to withhold 1 percent of wages for the State Disability Insurance program. The SDI tax is withheld on wages up to $100,880; the maximum amount withheld every year is $1,008.80. Hawaii, New Jersey, Rhode Island, New York and Puerto Rico also levy disability insurance taxes.
Choosing Income or Sales Tax
Since it is levied as a percentage of your wage income, the California SDI tax is deductible on your federal return. The amount you paid in SDI would be included in line 5, as long as you are deducting income and not sales taxes. If you choose to deduct sales taxes instead, you can either enter the amount of sales tax you actually paid or use a table of standard rates that the IRS provides. In this case, you won't be deducting disability or any other income tax.
If you pay disability insurance taxes to a foreign government, you may be able to roll that amount into the foreign tax credit, which comes directly off your tax liability. Although your Social Security payroll taxes go into a disability insurance trust fund, these taxes are not deductible, nor is any contribution you make to disability insurance through your employer -- unless it is part of a qualified "pre-tax" insurance plan meeting the IRS guidelines. In addition, if you collect payments from disability insurance, you will have to declare and pay taxes on that amount if your income exceeds certain limits set by the IRS.
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