There is no straightforward answer because some deductions are above the line, others must be itemized, some must exceed a threshold amount before being deductible, and certain ones are not deductible for alternative minimum tax purposes, while business deductions can offset both income and self-employment tax. In other words, there are many factors to consider, and the tax benefits differ for each individual, depending on his or her particular situation and tax bracket.
For most non-business deductions, the savings are based upon your tax bracket. For example, if you are in the 12% tax bracket, a $1,000 deduction would save you $120 in taxes. On the other hand, if you are in the 32% tax bracket, the $1,000 deduction will save you $320 in taxes. Even so, if your taxable income is close to transitioning into the next-lower tax bracket, the benefit will be lower. You also need to consider whether the particular deduction is allowed on your state return and what your state tax bracket is to determine the total tax savings. Currently, the maximum federal tax bracket is 37%, meaning the most benefit that can be derived from a $1,000 income tax deduction is $370. Some individuals justify making discretionary purchases just because they are tax-deductible. Even in the highest tax bracket, you are still paying $630 out of pocket ($1,000 − $370), so it does not make sense to incur a tax-deductible expense just for the tax deduction.
Some deductions, such as IRA and self-employed retirement plan contributions, alimony, and student loan interest, are adjustments to income or what we call above-the-line deductions. These deductions, to the extent permitted by law, provide a dollar deduction for every dollar claimed. Deductions that fall into the itemized category must exceed the standard deduction for your filing status before any benefit can be derived. In addition, medical deductions are reduced by 7.5% of your adjusted gross income (AGI) in 2018, and most cash charitable deductions are limited to a maximum of 60% of your AGI. Under the tax reform, the deduction for state and local taxes has been capped at $10,000.
The most beneficial deductions are business deductions that offset both income tax and, depending upon the circumstances, self-employment tax. For 2018, the self-employment tax rate is 12.4% of the first $128,400 of net self-employment income plus 2.9% for the Medicare tax, with no cap. Some high-income taxpayers may pay an additional 0.9% Medicare tax. For self-employed businesses with less than $128,400 of net income, the self-employment tax rate is 15.3%. Thus, for small businesses with profits of less than $128,400, the benefit derived from deductions generally will include the taxpayer’s tax bracket plus 15.3%. For example, for a taxpayer in the 24% tax bracket, the benefit could be as much as 39.3% (24% + 15.3%) of the deduction. If the deduction were $2,000, the tax savings could be as much as $806 or more, when the taxpayer’s state income tax bracket is included.
If you are planning an expenditure and expect the tax deduction to help cover the cost, contact the experts at Henssler Financial in advance to ensure that the tax benefit will be what you anticipate:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Disclosures: This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
