deductions don't make you money, do they?

[Delicateflower]

S/O from the student loan thread.

I'd always thought tax deductions worked like this: Assume your top tax rate is 10%. Pay $50 for tax deductible thing (ie, student loan or mortgage interest). Then, at tax time essentially reduce your taxable income by $50, so at the end of the day the tax deductible thing cost you $45 instead of $50.

But I see people talking about tax deductions as if they were tax credits. Am I confused or are they?

[polyhymnia]

Originally Posted by Delicateflower

S/O from the student loan thread.

I'd always thought tax deductions worked like this: Assume your top tax rate is 10%. Pay $50 for tax deductible thing (ie, student loan or mortgage interest). Then, at tax time essentially reduce your taxable income by $50, so at the end of the day the tax deductible thing cost you $45 instead of $50.

But I see people talking about tax deductions as if they were tax credits. Am I confused or are they?

They reduce what you owe. So in that sense, they make you money.

I paid about $400 in student loan interest last year.. we are close to the point where student loan interest deductions totally phase out, so it hardly made a difference, but when I put it into TaxCut the tax owed dropped by about $10.

[mar123]

credits are better than deductions, true. But I will take them!

[sunflower.mama]

You're right, they're confused! There is a big diff b/t deductions and credits. Credits are a dollar for dollar reduction in tax owed. Deductions reduce the amount subject to tax.

[Ironica]

Well, if the whatever you put that tax-deductible money toward is valuable to you (mortgage interest, charity you really care about), then you're paying less in taxes, and you have more money at the end of the year than you would otherwise.

If you budgeted around paying a certain amount of taxes, and the deductions mean you're paying less, you've got an increase in the money available in your budget, too.

But, if you don't owe taxes anyway (because your taxable income is below the threshold), then deductions do you no good at all.

[mar123]

Sort of. some deductions can help you qualify for actually getting more money from the government. I know a man that worked with dh- he always got back 5K more than he paid in b/c of deductions- I guess it is the EIC? I am not sure because we have never qualified for anything like this.

[Delicateflower]

I don't think I explained myself properly.

I'll try and restate my question (hopefully more clearly). Two people, both earning $1000 a year and paying $100 tax. Mr Blue spends $50 on a tax deductible widget in the hopes of reducing his tax obligation. Mr Red spends nothing.

After doing his tax return Mr Blue is out of pocket $145 (spent $50, $950 taxable income, $95 tax).

After doing his tax return, Mr Red is out of pocket $100 ($1000 taxable income, $100 tax).

Mr Blue has gotten a $50 widget for $45, but he is still substantially out of pocket for it.

So spending money to get a tax deduction should make no sense. You claim the deduction because it reduces the cost of the item by your top tax rate (like mortgage and student loan interest), and deductions for things that cost you nothing (like donating goods to a charity) are fantastic. But even with something like mortgage interest you only reduce it's cost by your top tax rate, so Mr Blue's widget was 10% less because that was his top tax rate.


Am I right or am I missing something? Can you tell we've always taken the standard deduction

[mightymoo]

Originally Posted by Delicateflower

I don't think I explained myself properly.

I'll try and restate my question (hopefully more clearly). Two people, both earning $1000 a year and paying $100 tax. Mr Blue spends $50 on a tax deductible widget in the hopes of reducing his tax obligation. Mr Red spends nothing.

After doing his tax return Mr Blue is out of pocket $145 (spent $50, $950 taxable income, $95 tax).

After doing his tax return, Mr Red is out of pocket $100 ($1000 taxable income, $100 tax).

Mr Blue has gotten a $50 widget for $45, but he is still substantially out of pocket for it.

So spending money to get a tax deduction should make no sense. You claim the deduction because it reduces the cost of the item by your top tax rate (like mortgage and student loan interest), and deductions for things that cost you nothing (like donating goods to a charity) are fantastic. But even with something like mortgage interest you only reduce it's cost by your top tax rate, so Mr Blue's widget was 10% less because that was his top tax rate.


Am I right or am I missing something? Can you tell we've always taken the standard deduction

I think you got it, it doesn't make any sense to buy something only for the deduction. It might make sense to buy something a certain way or at a certain time to have it qualify for a deduction, if you were going to buy it anyway.

[wifeandmom]

The examples given are sort of correct.

A deduction will decrease the amount of income you pay taxes on. So, if I donate $1000 to my church, I don't pay taxes on that donation amount.

In terms of what is left in my checking account for me to spend though, I'd have more left if I just paid taxes on the $1000 and didn't make the donation.

Even in the top tax bracket of 36%, a $1000 donation will save you $360 in taxes. Don't make the donation, pay $360 in taxes, and you'd still have $640 in your pocket when it was all said and done.

Bottom line? Deductions are great when it's something you plan to spend anyway, but if you're spending money JUST for the deduction, you're almost assuredly coming out with less money at the end of the day than if you'd just paid the tax.

The exception that comes to mind right away would be mortgage interest, in which case you might come out ahead overall if you'd spend as much or more renting as you would paying mortgage interest. For example, let's say the portion of my mortgage that is tax deductible (interest and property tax) comes to $6000 per year, which saves me $1500 in taxes (assuming 25% tax rate). That comes to $125/month savings in tax.

That means that I can basically pay $125/month MORE for my mortgage/property tax/interest than I could to rent something and come out exactly even in terms of money in my pocket.

Ex: A $2K/mo mortgage that includes interest and property tax would be the same as $1875/mo in rent since you'd have to pay an extra $125/month in tax without the mortgage deductions. Again, these are assuming money taxed at 25%.

[velochic]

Originally Posted by polyhymnia

They reduce what you owe. So in that sense, they make you money.

They don't reduce your actual tax liability. That's a tax credit. Deductions reduce your AGI, adjusted gross income, or the bottom-line amount on which taxes are owed. Ultimately, they do reduce what you owe, but only by the percentage of your marginal tax bracket.

Delicateflower and WifeandMom are correct. And I agree that unless you are going to buy something anyway, it's not going to save you enough money in tax liability to be worth it.

[applecider]

Yes, it always bugs me when I hear people talk about spending money for the deduction. "Oh, but it's a write-off", ok but you still just spent a bunch of $$, you idiot! (that's not a uav, is it? )

[p1gg1e]

Originally Posted by cody'smomma

Yes, it always bugs me when I hear people talk about spending money for the deduction. "Oh, but it's a write-off", ok but you still just spent a bunch of $$, you idiot! (that's not a uav, is it? )

Esp when it was yours to begin with ant the federal government took it!

[Delicateflower]

Originally Posted by p1gg1e

Esp when it was yours to begin with ant the federal government took it!

To build roads and schools and the army and the FDA, etc.

[Free Thinker]

We live in farm country, and hear this all the time. If you have a farm, you can deduct things like fencing, fertilizer, tractors, ect. and those are definately justifiable expenses of owning a farm, but you still are out the $$. We do have a farm and buy stuff for it, we kinda figure it's actually costing us 1/3 less b/c we would have paid that much in taxes anyway. For example, a 10K tractor only costs us closer to 7K total, when you figure in we would have paid 3K in taxes anyway. Same goes for health insurance, though! We pay about 7K per year for health insurance, and we get to deduct that from our taxable income, so it does help! You should never buy something just for the tax break, and especially if you cannot afford it, but if it's something you could really use in your business or farm, then it makes sense to buy it and get a tax break for it!

[RoundAbout]

You are right. It's basically just a discount on your taxes. Not to mention it only helps if you itemize.

My MIL is terrible about this. She just doesn't get the difference between a deduction and a credit.

[naupakamama]

This is a big vent of mine too. Even to the level of people saying that they don't want to pay off their house because they will lose the tax deduction. HUH??? So you want to pay extra interest just so you can get a small amount of it back in tax write off?

One of my older co-workers even wants to buy a second house just so that they will have the tax write off. When they payed off their main house they started paying so much in taxes in their perception. I guess it is easier to "see" the tax money leaving and not the mortgage payment - IDK.

[p1gg1e]

Originally Posted by Delicateflower

To build roads and schools and the army and the FDA, etc.

Still a waste! Love the FDA

[Sk8ermaiden]

Originally Posted by naupakamama

This is a big vent of mine too. Even to the level of people saying that they don't want to pay off their house because they will lose the tax deduction. HUH??? So you want to pay extra interest just so you can get a small amount of it back in tax write off?

Oh, this is my favorite. "Don't pay off the house early, you'll lose the tax deduction!" ....Umm, yes. And save thousands and thousands a year in interest, which saves you significantly more money than a tax deduction.

[mightymoo]

That's what bothers me about this whole tax deduction for buying a new car in 2009 that is part of the stimulus stuff. Great, so I can deduct the sales tax on the car, so what's the sales tax, $1-2K probably? So I'm saving myself maybe $200-600 by buying the car this year instead of next, but I'm paying for a new car all this year, a scenario which usually costs far more than $200-600. We will need to get my husband a new car eventually, even if we decide to buy a *new* car instead of an old one, we still come out way ahead if we drive his old car for another year. The tax deduction does not make it worth buying a new car sooner.

[polyhymnia]

Originally Posted by velochic

They don't reduce your actual tax liability. That's a tax credit. Deductions reduce your AGI, adjusted gross income, or the bottom-line amount on which taxes are owed. Ultimately, they do reduce what you owe, but only by the percentage of your marginal tax bracket.

Delicateflower and WifeandMom are correct. And I agree that unless you are going to buy something anyway, it's not going to save you enough money in tax liability to be worth it.

yeah, sorry, I wasn't specific enough. It's a benefit, but never something that's worth doing just on its own.