Sales Tax Slice: Federal Tax Reform Likely to Affect Sales Tax As Well

Federal tax reform has been a major headline around the country over the past several weeks, with pundits on both sides of the aisle weighing in on how the GOP plan for an overhaul of the Internal Revenue Code is likely to affect your bottom line. While there has been a lot of discussion about how the proposal may shake up state income taxes, one item that has been mostly missing from the analysis is how such changes could have an effect on sales and use taxes throughout the country.

The most obvious impact on individuals and businesses who pay sales tax would be the elimination of the state and local tax deduction. Although a number of Congressional Republicans are opposed to this adjustment, it appears to be necessary to pay for the rate cuts included in the plan, so it is worth considering its potential effect.

Many people only think of this as a deduction for state and local income taxes paid, but taxpayers have been able to choose between deducting either income or sales taxes since 2004. While the majority of taxpayers who itemize on their federal returns opt to deduct their state and local income taxes, the ability to deduct sales and use taxes instead is a boon to those living in states that impose a sales tax but not an income tax, specifically Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. It also tends to take the sting out of making large (taxable) purchases, such as a new car, new appliances for a kitchen remodel, or even a yacht or airplane.

However, getting rid of the ability to deduct sales and use taxes on a federal tax return may incentivize states to look for other ways to raise revenue. To the extent that the deduction causes states to prefer to impose taxes that are deductible on the federal level, states may begin to shift their attention to other types of tax that are not currently deductible. In the realm of sales tax, this could mean a shift from a general sales tax to excise taxes on purchases like alcohol, gasoline, hotel stays, and prepared food and beverages.

Additionally, if tax reform has the end result of decreasing the amount of federal money currently going to the states, taxpayers may instead see a surge in their state and local sales tax burdens. Harry P. Leonard, a deputy commissioner with New York City’s Department of Finance, has indicated that a reduction in federal funding may increase states’ efforts to collect revenue from remote retailers, as reported by Bloomberg BNA’s Ryan Prete.

At this point, the only thing we can be sure of is that tax reform is likely to remain a huge issue of debate and that any measure that passes on the federal level is likely to have reverberations throughout the state and local tax arena.

Continue the discussion on the BBNA State Tax Group on LinkedIn: What, if any, effects do you think federal tax reform will have on state and local sales tax? How should states plan for changes in the amount of federal funding they receive?

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