Monday, April 13, 2015
Is It Really Tax Deductible?
As we near tax day it makes sense to review a matter most people either don’t understand or don’t really think about – the issue of tax deductibility, what it really means and how people use it to sell goods, ideas and charitable causes.
another example of how we must look after ourselves rather than relying on consumer protection agencies, because when it comes to finances, bankers are a lot smarter than politicians and will come up with new products to take advantage of any rule changes.)
Since fewer than one in seven people even look at a tax form anymore (see graph), preferring to hand the box of receipts off to someone else or to wade through the hundreds of questions delivered by tax preparation software that mysteriously translates all the answers into the lines on a 1040 form, I think most don’t have a clue about the mild deceit going on here. Not everything that is legally tax-deductible and listed on your return provides any benefit at all.
Here’s how it works. Everyone can choose either itemizing those deductions or claiming an automatic standard deduction. Based on data from last year only about 31% chose to list all their deductions. The rest took the standard deduction. Deductions that may be itemized include mortgage interest, property taxes, certain other taxes, contributions to eligible charities, medical expenses (but only for the amount above 7.5% of your income) and certain other unreimbursed employee expenses, such as job travel, union dues, job education, etc.
The standard deduction, the one you could get no matter what is $6300 for a single person and $12,600 for a married couple. So the value of the first $12,600 of deductions for a married couple (filing jointly) is exactly zero! You could get it any way regardless of your other decisions! Suppose you have no major health expenses, mortgage interest of $6,000, property tax of $3000, state income tax of $2500 and donations of $1500; the total is only $400 above the standard deduction. If you are in the 25% tax bracket, your taxes are lowered by $100. On one hand, it’s nice to get an extra $100 back from the government. On the other hand, is that what you expected when the realtor sold you the house with the promise of tax deductibility? (And don’t forget, the interest paid will be going down every year as the principal is paid down and the standard deduction may go up, so you have less chance to reach that break-even point.)
I know it’s usually painful to think about taxes at all, but when someone is using an idea to sell you something, it’s wise to be informed and to have done a little of the math. In reality the only decisions that should be influenced by the promise of tax deductibility are the ones made after you know that the initial $12,600 has already been met.