What expense category is Other State and Local Taxes?

Beyond the major taxes, such as income and property, businesses are often subject to a variety of other state and local taxes. These can include industry-specific excise taxes, occupational taxes, or taxes based on gross receipts. For accountants and business owners, it's crucial to know that many of these are deductible business expenses.

However, the tax treatment can be nuanced, especially when it comes to sales tax. This guide will clarify how to categorize these various state and local taxes according to IRS rules, ensuring your business remains compliant and maximizes its deductions.

Other State and Local Taxes Category

The various state and local taxes that are directly attributable to your trade or business are an ordinary and necessary business expense. These costs are reported under the specific category of Taxes and Licenses.

IRS Publication 535 and Publication 334 confirm that you can deduct various federal, state, and local taxes directly related to your business operations.

Important Considerations When Classifying State and Local Taxes

The most critical factor is understanding which taxes are deductible and how to handle other taxes, like sales tax, which are treated differently.

Sales Tax on Business Purchases

This is a key distinction. Publication 535 is very clear that the sales tax you pay on goods or services for your business should not be deducted as a separate tax. Instead, the sales tax is treated as part of the cost of the item purchased.

• If the item is a currently deductible expense (like supplies), the sales tax is included in the supplies expense.
• If the item is a capital asset (like equipment), the sales tax is added to the asset's basis and recovered through depreciation.

Sales Tax Collected from Customers

If your business is required to collect sales tax from customers and remit it to the state or local government, those collected amounts are not included in your business's gross income, and you do not take a deduction when you pay them to the government. They are simply a liability you are passing through.

Deductible Excise and Occupational Taxes

• Excise Taxes: Publication 535 states that you can generally deduct all federal, state, and local excise taxes that are ordinary and necessary expenses of carrying on your business.
• Occupational Taxes: Publication 535 also confirms that you can deduct an occupational tax charged at a flat rate by a locality for the privilege of conducting business there.

Fuel Taxes

Taxes on gasoline, diesel, and other motor fuels are not deducted separately as a tax. As explained in Publication 535, these taxes are included as part of the cost of the fuel itself.

Tax Implications and Recordkeeping

To deduct qualifying state and local taxes, you must report them correctly and maintain proper documentation.

How to Report the Deduction

For a sole proprietor filing a Schedule C (Form 1040), deductible state and local taxes (other than income and property) are reported on Part II, Line 23, Taxes and licenses.

What Records to Keep

You must have documentary evidence to substantiate all tax payments. Your records should include:

• Tax bills or notices from the state or local government agency.
• Receipts for any tax payments made.
• Proof of payment, such as canceled checks or bank statements.

How Fyle Can Automate Tracking for State and Local Taxes

Fyle helps you manage and document your various tax payments, ensuring you have a complete and compliant record for tax time.

• Centralize Tax Bills: Forward tax bills and notices from government agencies directly to Fyle for a complete digital record.
• Track Every Payment: Capture each tax payment, whether made by check or bank transfer, to create a clear and unalterable payment history.
• Create a Clear Audit Trail: Fyle keeps the tax bill and the corresponding proof of payment together in one organized expense record.
• Automate Your Accounting: Sync the categorized tax expense directly to the correct GL account in QuickBooks, Xero, NetSuite, or Sage Intacct.