Can I Deduct Federal Taxes Paid?

June, 23 2023 by Steve Banner, EA, MBA

The answer to this question is maybe – but it all depends on where you live or what you do for a living.

Depending on which state you live in, the answer may change to “yes.” For the 2022 tax year, Alabama and Iowa allow you to reduce your state taxable income by the total amount of federal taxes that you paid for the year. Meanwhile, Missouri, Montana and Oregon allow you to deduct your federal taxes up to a certain maximum level. But as this blog is focused mainly on federal taxes and tax returns, we will confine our discussion to federal tax matters from this point onwards.

The hard and fast general rule is that you are not permitted to take a deduction for your federal income taxes on your federal tax return. This is bad news for wage and salary earners when it comes to preparing their Form 1040 individual tax return. However, the picture may be somewhat brighter for those taxpayers who have income from a trade or business. In that case, you still can’t take a deduction for your federal income taxes, but you can take business expense deductions for various other federal, state, local, and foreign taxes that are directly attributable to your trade or business.

The business-related taxes that you pay under the above headings are deductible if they are ordinary and necessary expenses that are part of the cost of doing business. The state, local and foreign taxes all speak for themselves, but you may be thinking that you have just read that federal income taxes are not deductible, so what are the other federal taxes that I might possibly deduct?

First of all, if you are self-employed and your net earnings from that self-employment are $400 or more, then you are generally liable to pay self-employment (SE) tax at the federal level. However, the tax code allows you to deduct one-half of your SE tax as an adjustment to your income when completing Form 1040.

SE tax is generally assessed at a total rate of 15.3% of your net self-employment income. This amount consists of two parts: 12.4% for Social Security tax; and 2.9% for Medicare tax. This brings us to our next scenario where federal tax can be deducted.

If your self-employment business has done so well that you need to hire some employees, you will find that, as an employer, you are responsible for withholding taxes from the salaries of your workers. Depending on your location, your withholding may include state as well as federal taxes. The federal amounts will include income tax (which is not deductible), as well as Social Security tax and Medicare tax. These two employment taxes are calculated at the same rate as the SE tax, but one-half of each is paid by the employee, and the other half by the employer.

For example, let’s say Mary’s gross salary for a pay period is $2,000. In addition to withholding income tax on her behalf, you as an employer must withhold ($2,000 x 12.4%/2 =) $124 for Social Security tax, and ($2,000 x 2.9%/2 =) $29 for Medicare tax. You will withhold the above employment taxes from Mary’s salary ($124 + $29 =) $153, and you must also match that amount with another $153 from your own funds. This $153 in employment taxes that you contribute on behalf of Mary is deductible as a business expense, together with the employment taxes that you pay on behalf of your other employees.

On another note, you are also deducting a federal tax when you claim the cost of fuel used for a motor vehicle in your business operations. But you’re probably not aware of it because the tax is built into the price you pay for your fuel. In other words, you’re getting a tax deduction without even having to think about it. If only the rest of our tax returns could be so easy!