Are tax deductions worth what you spend to get them?

The answer is no….  tax deductions are not worth what you spend to get them.  In fact, if you are thinking in this direction, or have been advised to, you are probably missing the point.  Please allow me to elaborate.

A “deduction” is one of the components of our income tax system. Basically, to calculate your income tax, you add up all of your income, subtract all of your deductions, and apply a rate. That’s it! There are all kinds of complicating factors along the way, for which I should be thankful about because it gives me something to do all day, but it’s important to keep all of this in perspective.

Deductions are only allowed for specific items.  For most of us, the list includes mortgage interest, property taxes, state income taxes, and donations to charity.  Businesses are generally allowed to deduct most expenditures needed to operate their business.

Let’s say for example your tax rate is 25% and you spend $3,000 for a new business computer.   Your tax savings of that purchase is $750 ($3,000 * 25%).   So, the computer only cost $2,250 after considering the $750 reduction to your taxes.

How about mortgage interest on a new home?  If you pay $10,000 in mortgage interest and your tax rate is 25%, you have reduced your taxes by $2,500 by paying that interest.  Similar to the previous example, that mortgage interest only cost you $7,500 after the tax benefit.

You are probably seeing my point.  This concept is so simple but so often overlooked.  Don’t get me wrong; tax deductions are a good thing, but they should never be the primary consideration in a purchase.  A tax deduction will reduce the net cost of a qualified expense or investment and that is how it should be considered.  They should never drive to decision to make a purchase.