How Much Are You Actually Saving by Writing Off Your Taxes?
Need a new computer? Write it off! Lunch at a trendy French restaurant? Write it off! There is a popular belief that when it comes to deductible expenses, they can be“written off”, and it’s like getting them for free. But it is not so. So how much do you actually save when you write off something? We consulted some tax experts for their (ahem) two cents.
“This is one of my favorite and often misunderstood concepts of taxation,” says Mark Dürrenberger, certified financial planner and author of The Millionaire of Our Day . “I think this misunderstanding was not helped by Seinfeld’s old remark that Jerry doesn’t know what it means to write it off, and that’s okay, because some big corporation understands it, and they are writing it off! “”
We’ve all seen this episode, and it’s not just a write-off of large corporations. Individuals also have the right to write off. (Although this new tax law puts many on the brink of death .) Writing off things may not mean what you think.
Tax incentives versus tax deductions
First, there is a big difference between tax breaks like an electric car loan or a kid’s tax credit (both of which look like they’re in the wheelhouse in 2024) and expenses that you are simply allowed to deduct. As the IRS explains , tax breaks reduce your income tax liability by dollar for dollar. “This means that the US $ 1,000 tax break saves US $ 1,000 in taxes,” they write.
On the other hand, tax deductions are deductions from your taxable income.
“In fact, a tax write-off lowers your taxes by reducing your taxable income by the amount of the write-off,” says Durrenberger. “This will save you any tax rate multiplied by the write-off cost.”
Deductions reduce your taxable income, but the amount you save on taxes depends on your tax category, the deduction itself, and how much you “deduct.” The financial site Zacks explains it well:
“This means you calculate your gross income for the year and then deduct expenses before calculating your taxes. If you made $ 50,000 and deducted $ 100 of expenses, you would pay taxes on $ 49,900. ”
In other words, subtracting $ 100 of business expenses doesn’t mean you are going to save $ 100. “You will save on taxes that you would have to pay on that hundred dollars,” explains Dürrenberger. This is why your tax category matters.
Determine Your Limiting Tax Range
If it’s not hard enough yet, did you know that you are not just paying one tax rate? Our tax system is tiered, which means you pay a percentage on each income group. Here are the tax brackets for 2017:
Let’s say you made $ 50,000 in a year. This does not mean that you are paying 25% in tax. You only pay this amount for anything over $ 37,950. Your first $ 9325 will actually only be taxed at the 10% rate.
However, the highest level applicable to your income is called your marginal tax category. In our example, your marginal tax rate would be 25%. And you will need this number if you want to know how much your deductions will actually save you.
How to calculate savings
We’ll learn how to use your tax tier limit soon. Before we do that, let’s be clear about something. Not only is a deduction not a dollar to dollar saving, you also cannot deduct all expenses entirely. There are limits! For example, for business lunches and business travel dinners – you can usually only deduct 50% of the cost.
To actually calculate how much you will save after deducting federal income tax, you will need to multiply the actual amount of the deduction (subject to the percentage cap) by your tax bracket. “For example, if your marginal tax rate is 25%, you will save 25 cents in federal income tax on every dollar you can claim as deductible business expenses,” Nolo explains. If you have a $ 100 deduction, you will save $ 25. If you write off a $ 50 business lunch, you will save about $ 6. ($ 50/2 x 0.25).
However, this is a kind of general rule. It can be tricky because of these parentheses. Let’s say your deduction is $ 1,000, but you barely fit into the 28% group for a few hundred dollars (your taxable income is $ 38,250). In this case, the write-off is greater than the amount you are taxing in that margin group, so you will not get an exact figure when calculating the 28% write-off. Sachs puts it this way :
“Let’s say you make enough to get into the 28 percent group, but only for $ 300. To calculate how much you save by subtracting $ 1,000, you need to multiply $ 300 by 28 percent, and the remaining $ 700 by 25 percent — the rate at which that money would otherwise be taxed. ”
This gives you an accurate idea of how much you will actually save. Of course, if you’re just looking for a rough figure, you can pick one bet and still get a relatively close figure. Just don’t expect your write-offs to pay off.