Tax Deductible Doesn’t Mean Free!

This is something that just drives me crazy. People often talk about how their purchases were complete steals because they are tax deductible.

Many people think that since something is ‘tax deductible’ that it’s essentially free.

WRONG!

What it means is that you are able to deduct the cost from your taxable income, NOT your tax bill. Essentially, you get a small tax break, but rarely does the purchase turn from a bad one into a good one.

Here’s a clear example:

Let’s say your taxable income is $50,000. You give $1,000 to charity. That contribution is tax deductible.

The only calculation needed is to subtract the tax-deductible amount from the taxable income.

So your taxable income becomes $49,000.

The mistake many people make is that they think that the $1,000 comes off the final tax bill.

THAT IS WRONG!

The savings you gain from tax-deductible purchases are your tax bracket multiplied by the purchase amount. So if you’re in the 25% tax bracket, a $1,000 contribution to charity only costs you $750.

So you save $250. It’s an incentive, but be careful about thinking that your new windows are a steal. They still cost $750.

If you need new windows, knock yourself out, and enjoy the savings!

Tax Deductible Doesn’t Mean Free!

Sweating the Big Stuff Staff

9 thoughts on “Tax Deductible Doesn’t Mean Free!

  1. I see this ALL THE TIME with cars and restaurant bills. I’ll have a buddy bragging about his new car, and then when we start talking price his response will be “Don’t worry it is deductible.” But it is not like the whole thing is deductible?! I’d love to know what inspired this post

    1. @Evan, Nothing specific actually, but I hear this ALL THE TIME! People talking about washers and dryers, new energy efficient windows, etc. Bret makes a great point below. Even if it’s deductible, you may not even be getting any savings out of it!

  2. Unless you have a lot of write-offs, you don’t save much on your tax bill with deductions. That’s because the IRS keeps raising the personal deduction, which is now $11,400, if you are married filing jointly. So, the first $11,400 in write offs are essentially worthless.

    1. @Bret @ Hope to Prosper, That’s right, and the standard deduction for single filers is $5,700. If your tax-deductible expenses don’t exceed that, you’re not saving anything at all!

  3. The mortgage deduction suckers people into not paying off their home as well.
    Good points all!

  4. Who are these people? I never hear people say this. By the way, even though the tax savings aren’t huge, I think charitable contributions are still an essential part of any budget. They are as good for the soul as they are for our neighbors in need (if not more so!).

  5. This is just as illogical as my aunt not taking her social security payments because she’d have to pay more taxes. Yes, but you will have more money overall.

  6. I hear this argument in favor of buying a house a lot. Everyone also talks about how mortgage interest is deductible, and how that makes buying better than renting. I never understood that argument, and now I have something to respond with when someone presents it. Thanks!

  7. I totally agree with you. I used to work with a guy who thought that an interest only mortgage was great for him because he got to “write off” the full amount of his payment. No matter how I explained to him that he wasn’t paying down his mortgage and that it still cost him money, he thought that he basically would get his payments back at the end of the year in the form of a tax refund check!!! So frustrating!!

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