What does tax-deductible mean?
June 6, 2015 8:24 AM Subscribe
If some fees you pay are tax-deductible does that mean the gov't gives you all the money back at the end of the year? Or only a part of the money back? How can you tell how much you will get back at the end?
It means you can deduct the fees against your income for the purposes of figuring out how much tax you owe. So you don't get all the money back. You save the amount of extra tax you would have paid if those amounts had been considered part of your income. So if your total income is $150 and your tax rate is 20% you pay $30 in tax. If you had tax-deductible fees of $50, your income goes to $100 and you only pay $20 in tax. Total savings (or money "back") = $10.
posted by yogalemon at 8:30 AM on June 6, 2015 [5 favorites]
posted by yogalemon at 8:30 AM on June 6, 2015 [5 favorites]
Usually it means you can deduct the amount from your income when it comes times to calculate your taxes, so how much taxes you "get back" (or don't have to pay) depends on your tax bracket. Precisely how this works varies between jurisdictions.
posted by Emanuel at 8:30 AM on June 6, 2015
posted by Emanuel at 8:30 AM on June 6, 2015
A tax credit reduces your actual tax owing directly, while a tax deduction reduces your income so indirectly you'll pay less in tax.
posted by GhostintheMachine at 9:00 AM on June 6, 2015 [4 favorites]
posted by GhostintheMachine at 9:00 AM on June 6, 2015 [4 favorites]
Also, keep in mind that many common deductible expenses are subject to limitations [in the US]. Medical expenses are deductible only to the extent they exceed, in total, 10% of your adjusted gross income. "Miscellaneous itemized deductions" are deductible only to the extent they exceed, in total, 2% of your AGI. Other deductions are phased out at certain income levels or have their benefit reduced by virtue of the alternative minimum tax. If you are "self employed" then there are different rules. States have their own sets of rules and often do not conform to a number of federal deductions.
TL;DR: shit is complicated
Do you have a particular type of expense in mind? That would help with the calculating the benefit part of your question.
posted by melissasaurus at 9:27 AM on June 6, 2015 [1 favorite]
TL;DR: shit is complicated
Do you have a particular type of expense in mind? That would help with the calculating the benefit part of your question.
posted by melissasaurus at 9:27 AM on June 6, 2015 [1 favorite]
Everyone above has it right. But the simple way to figure out how much you get back is just to multiply it by your tax bracket. If you are in a 30% tax bracket, then your taxes at the end of the year will be lower by 30% of the tax-deductible amount. Or, if you get a tax refund, your refund will be larger by 30% of the tax-deductible amount.
An important point though is that if your income is low enough, tax-deductible means nothing to you. If you effectively pay no taxes because, say, your income is less than the personal exemption ($4000 federally in the US, I believe), then you will not get any money back.
posted by 256 at 9:29 AM on June 6, 2015
An important point though is that if your income is low enough, tax-deductible means nothing to you. If you effectively pay no taxes because, say, your income is less than the personal exemption ($4000 federally in the US, I believe), then you will not get any money back.
posted by 256 at 9:29 AM on June 6, 2015
Everyone above has it right. But the simple way to figure out how much you get back is just to multiply it by your tax bracket. If you are in a 30% tax bracket, then your taxes at the end of the year will be lower by 30% of the tax-deductible amount. Or, if you get a tax refund, your refund will be larger by 30% of the tax-deductible amount.
This is not precisely true for all types of deductible expenses.
For example, home mortgage interest tax-deductible. But you only can take the deduction if you itemize. The thing about that standard deduction is that because you have that option, itemized deductions only have any value at all once they exceed that amount. So, you're not really getting 30% of your home mortgage interest. You're getting 30% of your home mortgage interest, to the extent that it plus other itemized deductions exceed the standard, which is going to be at least $6000.
Things which are tax-deductible which don't fall on schedule A, like your student loan interest, will be simpler to calculate. But every different class of deduction or credit is going to have different requirements.
If any of these things sound confusing to you, OP, the answer to this really is that you figure out how much it's going to be worth to you by visiting a good accountant and having them work with you. Some people are good at doing their own taxes, some aren't. I have a graduate degree in this and still wouldn't want to try to calculate this by hand. Once you have an ongoing relationship with your tax preparer, it's easier to just drop them a line and ask what kind of tax savings you're actually going to get from this thing you want to do.
posted by Sequence at 10:15 AM on June 6, 2015 [1 favorite]
This is not precisely true for all types of deductible expenses.
For example, home mortgage interest tax-deductible. But you only can take the deduction if you itemize. The thing about that standard deduction is that because you have that option, itemized deductions only have any value at all once they exceed that amount. So, you're not really getting 30% of your home mortgage interest. You're getting 30% of your home mortgage interest, to the extent that it plus other itemized deductions exceed the standard, which is going to be at least $6000.
Things which are tax-deductible which don't fall on schedule A, like your student loan interest, will be simpler to calculate. But every different class of deduction or credit is going to have different requirements.
If any of these things sound confusing to you, OP, the answer to this really is that you figure out how much it's going to be worth to you by visiting a good accountant and having them work with you. Some people are good at doing their own taxes, some aren't. I have a graduate degree in this and still wouldn't want to try to calculate this by hand. Once you have an ongoing relationship with your tax preparer, it's easier to just drop them a line and ask what kind of tax savings you're actually going to get from this thing you want to do.
posted by Sequence at 10:15 AM on June 6, 2015 [1 favorite]
As everyone has pointed out, in the US it means that when you file your taxes, you can deduct the tax deductible amount of whatever expense from your income before calculating the total amount of tax you owe. But if none of the above explanations about the standard deduction have made sense, here's an analogy:
If you have Amazon Prime, you get "free" 2-day shipping on many items, but you will occasionally come across something that is both physically small and low in price, which Amazon will label an "add-on item." That single item is not enough to qualify you for your Prime shipping offer, but if you order something else that is eligible, the add-on item will also ship for "free."
When you file your taxes every year you are supposed to add up all of the various deductions you can take (medical expenses above a certain threshold, mortgage interest, local taxes paid during the year, etc). If that number is higher than the standard deduction, you "itemize your deductions" and list everything, which is where all those little $25 sponsorships for cancer research and the Humane Society and whatever start to add up. But if you don't have at least one major deduction all your little deductions aren't likely to add up to enough, and you'll just take the standard deduction.
Also you may come across something if you go to, say, a fund raising dinner, where a ticket is $125, but there's a note to the effect that it "includes $75 tax-deductible donation." You can't deduct the cost of the dinner (calculated at $50 for the catering and open bar in my contrived example) but you can deduct the part that's actually the fund raiser. Same thing if you donate to PBS and they send you a DVD set or whatever. If you are getting something out of the deal, that something has to be subtracted from the overall price in order to determine the tax-deductible amount.
posted by fedward at 10:35 AM on June 6, 2015
If you have Amazon Prime, you get "free" 2-day shipping on many items, but you will occasionally come across something that is both physically small and low in price, which Amazon will label an "add-on item." That single item is not enough to qualify you for your Prime shipping offer, but if you order something else that is eligible, the add-on item will also ship for "free."
When you file your taxes every year you are supposed to add up all of the various deductions you can take (medical expenses above a certain threshold, mortgage interest, local taxes paid during the year, etc). If that number is higher than the standard deduction, you "itemize your deductions" and list everything, which is where all those little $25 sponsorships for cancer research and the Humane Society and whatever start to add up. But if you don't have at least one major deduction all your little deductions aren't likely to add up to enough, and you'll just take the standard deduction.
Also you may come across something if you go to, say, a fund raising dinner, where a ticket is $125, but there's a note to the effect that it "includes $75 tax-deductible donation." You can't deduct the cost of the dinner (calculated at $50 for the catering and open bar in my contrived example) but you can deduct the part that's actually the fund raiser. Same thing if you donate to PBS and they send you a DVD set or whatever. If you are getting something out of the deal, that something has to be subtracted from the overall price in order to determine the tax-deductible amount.
posted by fedward at 10:35 AM on June 6, 2015
You haven't told us what kind of tax deductible fee you're talking about, but one common example where people tell you that a fee is deductible is investment expenses/financial advisory fees/tax prep fees. Be careful if this what you're asking about. Investment advisers love to promote how their fees are tax deductible, but the actual savings can be minimal or zero for many people.
As melissasaurus points out, these fees, among certain other deductions, are only deductible as "miscellaneous itemized deductions." To take a tax deduction for them, you first have to itemize your deductions instead of taking the standard deduction (you'd only do this if it works out so you'd pay less tax this way; in other words if your itemized deductions added together are greater than your standard deduction). Then add up all your "miscellaneous itemized deductions" for the year. The amount you can deduct is the portion that is above 2% of your "Adjusted Gross Income" (AGI) (your total income minus a couple of possible things, basically). So if you have an AGI of $50,000 for the year and you have $800 in deductible investment fees, you couldn't deduct any of them, because you can only deduct the amount above $1,000 (2% of $50,000). If you had $1,200 in fees, you could only deduct $200 of them, which might be worth around $30-$50 in tax savings, depending on your filing status and other factors.
If you tell us more about the specific situation, we can give you a better idea as to what, if anything, the deduction might actually be worth.
posted by zachlipton at 11:10 AM on June 6, 2015
As melissasaurus points out, these fees, among certain other deductions, are only deductible as "miscellaneous itemized deductions." To take a tax deduction for them, you first have to itemize your deductions instead of taking the standard deduction (you'd only do this if it works out so you'd pay less tax this way; in other words if your itemized deductions added together are greater than your standard deduction). Then add up all your "miscellaneous itemized deductions" for the year. The amount you can deduct is the portion that is above 2% of your "Adjusted Gross Income" (AGI) (your total income minus a couple of possible things, basically). So if you have an AGI of $50,000 for the year and you have $800 in deductible investment fees, you couldn't deduct any of them, because you can only deduct the amount above $1,000 (2% of $50,000). If you had $1,200 in fees, you could only deduct $200 of them, which might be worth around $30-$50 in tax savings, depending on your filing status and other factors.
If you tell us more about the specific situation, we can give you a better idea as to what, if anything, the deduction might actually be worth.
posted by zachlipton at 11:10 AM on June 6, 2015
As everyone has mentioned, a tax deductible expense only matters if it's above the "standard deduction" ($6200 for a single person). So if you spend more than that, you save the amount of income tax you would have paid otherwise on anything over that. "Itemizing" is where you list all your deductions out to prove to the IRS that you're allowed to take that amount out of your income.
I own a business so my deductions are pretty substantial, as business expenses don't count as income. For me this is literally tens of thousands of dollars in taxes I'm saving every year but it requires hiring a good accountant to make sure everything is ok and done how the IRS wants it. It's also not money I get "back" it's just money I don't owe on my tax bill in April.
For the average individual, none of this is worth it and you should just take the standard deduction. If you think otherwise, hire an accountant.
posted by bradbane at 12:24 PM on June 6, 2015
I own a business so my deductions are pretty substantial, as business expenses don't count as income. For me this is literally tens of thousands of dollars in taxes I'm saving every year but it requires hiring a good accountant to make sure everything is ok and done how the IRS wants it. It's also not money I get "back" it's just money I don't owe on my tax bill in April.
For the average individual, none of this is worth it and you should just take the standard deduction. If you think otherwise, hire an accountant.
posted by bradbane at 12:24 PM on June 6, 2015
"For the average individual, none of this is worth it and you should just take the standard deduction. If you think otherwise, hire an accountant."
Whether that's true depends on whether you rent or own (and if you own, how long you have owned your home and thus the ratio of interest to principle in your mortgage payments), and whether you pay a substantial amount in state income taxes.
Since you can deduct mortgage interest on your primary residence, and state income tax (or sales tax, but not both), it's often advantageous to itemize if you own a home, especially if you also make significant charitable contributions.
posted by brianogilvie at 3:35 PM on June 6, 2015 [1 favorite]
Whether that's true depends on whether you rent or own (and if you own, how long you have owned your home and thus the ratio of interest to principle in your mortgage payments), and whether you pay a substantial amount in state income taxes.
Since you can deduct mortgage interest on your primary residence, and state income tax (or sales tax, but not both), it's often advantageous to itemize if you own a home, especially if you also make significant charitable contributions.
posted by brianogilvie at 3:35 PM on June 6, 2015 [1 favorite]
This thread is closed to new comments.
posted by sonic meat machine at 8:28 AM on June 6, 2015 [3 favorites]