Need a new computer? Write it off! Lunch at a fancy French restaurant? Write it off! There’s a prevailing belief that, when it comes to deductible expenses, you can “write them off” and it’s like getting them for free. But that’s not exactly true. So how much do you actually save when you write something off? We consulted some tax experts for their (ahem) two cents.
“This is one of my absolute favorite frequently misunderstood tax concepts,” says Mark Durrenberger, a Certified Financial Planner and author of The Modern Day Millionaire. “I think that misunderstanding wasn’t helped by the old Seinfeld quip that Jerry doesn’t knows what ‘writing it off’ means, and that’s fine because some big corporation does, and ‘they’re the ones writing it off!’”
We’ve all seen the episode, and it’s not just big corporations writing things off. Individuals are entitled to write-offs, too. (Although so many are on the chopping block thanks to this new tax bill.) But writing stuff off might not mean what you think it means.
Tax Credits vs. Tax Deductions
First, there’s a big difference between tax credits, like the Electric Vehicle Credit or the Child Tax Credit (both of which look like they’re on the chopping block in 2024), and expenses you’re merely allowed to deduct. As the IRS explains, tax credits give you a dollar-for dollar reduction of your income tax liability. “This means that a $1,000 tax credit saves you $1,000 in taxes,” they write.
Tax deductions, on the other hand, are deductions from your taxable income.
“In effect, a tax write off reduces the taxes you’ll owe by reducing your taxable income by the amount of the write off,” Durrenberger says. “This saves you whatever your tax rate is multiplied by the cost of the write off.”
Deductions lower your taxable income, but the amount you save on taxes depends on your tax bracket, the deduction itself, and how much you’re “writing off.” Finance site Zacks explains it well:
“That means you calculate your gross income for the year and then subtract expenses before figuring your taxes. If you earned $50,000 and deducted a $100 expense, you would pay taxes on $49,900.”
In other words, if you deduct a $100 business expense, that doesn’t mean you’re going to save $100. You’ll save on the taxes you would have had to pay on that hundred bucks, Durrenberger explains. This is why your tax bracket matters.
Figure out Your Marginal Tax Bracket
If that’s not already complicated enough, did you know that you don’t just pay one tax rate? Our tax system is a tiered one, meaning you pay a percentage on each bracket of income. Here are the tax brackets for 2017:
Let’s say you earned $50,000 for the year. That doesn’t mean you pay a tax rate of 25%. You only pay that amount for anything over $37,950. Your first $9,325 would actually only be taxed at 10%.
However, the highest bracket that applies to your income is called your marginal tax bracket. In the case of our example, your marginal tax bracket would be 25%. And you’ll need this number if you want to know how much your deductions will actually save you.
How to Calculate Your Savings
We’ll get to how to use your marginal tax bracket in a moment. Before we do, let’s clear something up. Not only is a deduction not dollar-for-dollar savings, you also can’t fully deduct every expense. There are limits! For example, with the charity deduction (which might not even be a thing for 2018 taxes), you can typically only deduct 50% of the donation. Same goes for business meals and meals while traveling for business — generally, you can only deduct 50% of the cost.
In order to actually calculate how much you’ll save with a federal income tax deduction, you will need to multiply the actual amount of the deduction (considering the percentage cap) by your marginal tax bracket. “For example, if your marginal tax bracket is 25%, you will save 25¢ in federal income taxes for every dollar you are able to claim as a deductible business expense,” Nolo explains. If you have a $100 deduction, you would save $25. If you write off a $50 business meal, you would save about 6 bucks. ($50/2 x 0.25).
This is sort of a general rule, though. It can get tricky because of those brackets. Let’s say the amount of your deduction is $1,000 but you just barely made it into the 28% bracket by a few hundred bucks (your taxable income is $38,250). In this case, the write-off exceeds the amount you’re taxed at in that marginal bracket, so you’re not getting an exact figure when you calculate your write-off by 28%. Zacks puts it this way:
“Suppose you earn enough to be in the 28 percent bracket, but only by $300. To calculate how much a $1,000 deduction would save you, you would multiply $300 by 28 percent, and the remaining $700 by 25 percent, the rate at which that money would otherwise be taxed.”
That gives you an exact idea of how much you’ll actually save. Of course, if you’re just looking for a ballpark figure, you can go with one rate and still get a relatively close number. Just don’t expect your write-offs to pay for themselves.