deductions don't make you money, do they? - Mothering Forums

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#1 of 25 Old 05-01-2009, 08:35 PM - Thread Starter
 
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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?
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#2 of 25 Old 05-01-2009, 08:45 PM
 
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Originally Posted by Delicateflower View Post
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.

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#3 of 25 Old 05-01-2009, 09:57 PM
 
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credits are better than deductions, true. But I will take them!
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#4 of 25 Old 05-01-2009, 10:01 PM
 
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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.

Katherine mother to DS 8/03 and DD1 9/06 and DD2 6/10
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#5 of 25 Old 05-01-2009, 10:46 PM
 
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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.
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#6 of 25 Old 05-01-2009, 11:16 PM
 
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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.
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#7 of 25 Old 05-01-2009, 11:52 PM - Thread Starter
 
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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
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#8 of 25 Old 05-02-2009, 12:59 AM
 
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Originally Posted by Delicateflower View Post
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.

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#9 of 25 Old 05-02-2009, 06:40 AM
 
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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%.
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#10 of 25 Old 05-02-2009, 09:51 AM
 
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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.
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#11 of 25 Old 05-02-2009, 11:54 AM
 
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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? )

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#12 of 25 Old 05-02-2009, 12:03 PM
 
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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!
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#13 of 25 Old 05-02-2009, 12:30 PM - Thread Starter
 
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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.
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#14 of 25 Old 05-02-2009, 12:41 PM
 
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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!
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#15 of 25 Old 05-02-2009, 03:45 PM
 
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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.
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#16 of 25 Old 05-02-2009, 03:59 PM
 
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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.

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#17 of 25 Old 05-02-2009, 06:30 PM
 
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To build roads and schools and the army and the FDA, etc.
Still a waste! Love the FDA
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#18 of 25 Old 05-02-2009, 07:35 PM
 
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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.

I'm Kellie :, married to Chris , and mom to one baby girl (7/12/09).
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#19 of 25 Old 05-02-2009, 07:46 PM
 
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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.

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#20 of 25 Old 05-03-2009, 01:00 AM
 
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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.

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#21 of 25 Old 05-03-2009, 08:51 PM
 
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Also, remember tax deductions are much more meaningful to those in a higher tax bracket...if you're in the 35% bracket, it's a big deal. 5%...not such a big deal!

Katherine mother to DS 8/03 and DD1 9/06 and DD2 6/10
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#22 of 25 Old 05-03-2009, 10:53 PM
 
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What if you were on the borderline between two tax brackets, would donating bring you back to the lower bracket?
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#23 of 25 Old 05-04-2009, 12:03 AM - Thread Starter
 
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What if you were on the borderline between two tax brackets, would donating bring you back to the lower bracket?
It's irrelevant, because you only pay that rate on the money in that bracket.

For example, if you're single and you earn $95,000 a year;

On the first $8350 you pay 10% tax
on the next $25,600 you pay 15% tax
on the next $48,300 you pay 25% tax
on the next $12,750 you pay 28% tax


Your overall tax rate is only 21.4%, even though you'd say you're in the 28% bracket.

The tax brackets are here http://www.moneychimp.com/features/tax_brackets.htm
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#24 of 25 Old 05-04-2009, 12:13 AM
 
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The tax bracket thing is what always stumps DH.

Anyway, no, it makes no sense whatsoever to buy something for the write off. It only makes a difference if it's something you were going to do anyway, like give to this charity with tax deduct. status or that one without. It can also make something make more sense to someone, like maybe I really want a $50 widget, but I can't quite justify $50. If it's deductible and I would be fine paying $40, that might push it over into, okay, let's go for it.

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#25 of 25 Old 05-05-2009, 05:26 AM
 
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What if you were on the borderline between two tax brackets, would donating bring you back to the lower bracket?

For simplicity sake, let's say you have a taxable income of $45K. Let's also say that income under $40K is taxed at 10% and income over $40K is taxed at 20%. (Again, these are not accurate numbers, just simple ones for illustration.)

So, you look at it and say, "Gosh, there's really no point in making $45K if it means I'm going to be in the 20% tax bracket instead of the 10% tax bracket." You proceed to donate $5K to your church, thus bringing your taxable income back to $40K and your tax bracket back to 10%.

The problem with this scenerio is that ONLY the income over $40K would be taxed at 20%. So, if you made no donation to your church, you'd pay $1000 on the income above $40K (20% of $5K). That would leave you $4K to spend as you wanted to.

The 10% tax on the first $40K is going to be $4K no matter what. It's not suddenly going to double to $8K on the first $40K simply because you've got *some* income in the 20% tax bracket.

It's really only a matter of what you do with the remaining $5K of taxable income. Yes, you can donate it or use it for any other tax deductible purpose, therefore eliminating the 20% tax on that money. But you could also just pay the $1K in taxes and have $4K to spend on something that is NOT tax deductible.

I like how someone else put it earlier.....It's more like you're getting a discount on whatever it is you're paying for if it's tax deductible. The farming example is a good one. If I am a farmer and buy a piece of equipment that is tax deductible, I can pay $10K for it, knowing that I'm saving myself $2500 in taxes (assuming a 25% tax bracket for that money). If I *don't* buy the tractor, it's not like I'm going to have $10K in my pocket. I'm going to have to pay the $2500 in taxes first, leaving me $7500.

However, it should be obvious that it doesn't make sense to buy the new tractor JUST for the tax deduction because if I didn't buy it and paid the taxes on the $10K, I'd have $7500 left in my pocket vs. nothing left in my pocket and a tractor I don't need.

Another example would be going on a trip that offers continuing education credits while you are at a tourist type location. DH's job has tons of these...you can go on a cruise and earn CEU's while you're there. You can go to a ski resort, an island somewhere in the Bahamas, etc. Because the trip involves earning CEU's, which is required for DH's licensure, we could go on one of these trips and write off the costs of going (with some exceptions).

We could go on a $5K trip, pay for it with pre-tax dollars, and save ourselves over $1500 in taxes. We're obviously still out nearly $3500 vs. if we'd just paid the tax on that $5K, but we could take a nice trip for a "reduced" amount. Make sense?
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