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I'm trying to understand how Deductible Taxes work in United States, and what I can actually deduct in the scenario where I don't have taxes withheld.

According to IRS.gov it says

To be deductible, the tax must be imposed on you and you must have paid it during your tax year. Taxes may be claimed only as an itemized deduction on Form 1040, Schedule A (PDF), Itemized Deductions.

They way I understand that statement is that I can deduct taxes withheld from my paycheck throughout the year - (please correct me if I'm wrong).

What if I chose not to withhold taxes throughout the year and instead chose to pay all my taxes at once at the time of tax filing?

Or if I'm a sole proprietor and get paid from my clients?

Do I deduct the tax amount that I will pay for that year?

  • Whether withheld or paid directly, State, local and foreign taxes paid by you are deductible on your Federal tax return. Note that you may not deduct both State income tax and State sales tax, you must choose one or the other. (Of course Federal taxes paid are not deductible, they're credits against taxes owed.) – David Schwartz Feb 1 '17 at 0:03
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There are several questions here but I'll try my best.

Deductible Taxes

  • State, local, and foreign income taxes
  • State and local general sales taxes
  • State, local, and foreign real estate taxes, and
  • State and local personal property taxes

So at the end of the year when you file your federal income tax return for 2016, you may be able to deduct those types of state, local and foreign taxes paid in 2016 from your federal taxes (if you itemize deductions). You can only deduct 1 of the 2 from state, local income taxes OR sales taxes.

They way I understand that statement is that I can deduct taxes withheld from my paycheck throughout the year - (please correct me if I'm wrong)

Yes, from the link you provide:

The following amounts are also deductible:

  • Any estimated taxes you paid to state or local governments during the year, and
  • Any prior year's state or local income tax you paid during the year.

However, I believe you would normally deduct the amount of total tax paid from your state or local tax return. What would happen if you deducted the estimated or withheld state tax from your federal return and then when you did your state return you got a refund? You would need to go back and amend your federal return.

Tax Withholding

What if I chose not to withhold taxes throughout the year and instead chose to pay all my taxes at once at the time of tax filing?

You will incur a penalty from the IRS. For W-2 employees this is normally avoided by completing the form W-4 so that appropriate taxes are withheld.

Or if I'm a sole proprietor and get paid from my clients?

You are required to make quarterly estimated tax payments.

Do I deduct the tax amount that I will pay for that year?

This isn't a deduction. You make quarterly payments, and when you file, those payments will be credited towards your tax liability.

As for filing/paying state income taxes, there are 50 different answers.

  • Thank you for a very detailed answer. A quick follow up question if you don't mind :) In the case of being Self Employed, you said its not a deduction, how would I get taxes that I pay deducted? Also what did you mean by "those payments will be credited towards your tax liability"? If I paid quarterly I theoretically should not have to pay anything additionally at the end of the year, no? – AlexVPerl Jan 31 '17 at 20:37
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    The quarterly payments are to the IRS for federal taxes. You pay it towards your federal tax liability, so it won't be "deducted" from your earnings for tax calculations, it will be credited towards the tax that you owe. As for paying additional, you may or may not. The estimation is not perfect and you may have other money that is taxable from other sources that raises your tax liability, or you may have deductions that lower your tax liability and you get a refund. I would never count on it coming out even. – AbraCadaver Jan 31 '17 at 20:41
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    You would deduct what you actually PAID in 2016. So if you paid your 2015 state taxes in 2016 you would deduct those and wait to deduct your 2016 state taxes when filing for the year that they are paid. – AbraCadaver Jan 31 '17 at 20:48
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    What would happen if you deducted the estimated or withheld state tax from your federal return and then when you did your state return you got a refund? : in April 2017 you deduct what you paid in 2016. If there is a refund from the state in April 2017, you claim that as income on the return you file in April 2018 – mhoran_psprep Jan 31 '17 at 21:13
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    That's right. If you got a State tax refund, you wouldn't amend the Federal return for a year other than the one in which you actually received the refund. The refund would be taxable income in the year you received it. – David Schwartz Feb 1 '17 at 0:05
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The rule is simple: you deduct taxes in the year that you pay them.

For withholding of state income tax, if you get state tax taken out of your check in 2016, that counts as paying the tax. You can deduct that on your 2016 tax return.

If you pay estimated tax quarterly in 2016, those state tax payments would also be deductible on your 2016 tax return.

If you underpaid your state tax in 2016 and end up having to send extra tax in when you fill out your 2016 state tax return in 2017, that extra tax you paid would not be deductible on your federal return until your 2017 return, since you paid it in 2017.

It works the same way for taxable state tax refunds: if you need to add a refund to your income, you do it in the year you received the refund. So if you overpaid your state taxes in 2016, and you are due a refund which the state sends you in 2017, you would add that refund back into your income on your 2017 federal return.

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If you are not an 'employee' as defined in the "Internal Revenue Code 26 USC - Subtitle C - Chapter 24 - COLLECTION OF INCOME TAX AT SOURCE ON WAGES" then your remuneration (i.e. pay) is not 'wages' and therefore not income and that remuneration is not subject to income tax, because you don't pay income tax on something that is not income.

§3401. Definitions (a) Wages

For purposes of this chapter, the term "wages" means all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash; except that such term shall not include remuneration paid— ... ... (c) Employee

For purposes of this chapter, the term "employee" includes an officer, employee, or elected official of the United States, a State, or any political subdivision thereof, or the District of Columbia, or any agency or instrumentality of any one or more of the foregoing. The term "employee" also includes an officer of a corporation.

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