A Tax “Write-off” of an Item Doesn’t Make It Free

People oftentimes justify paying for items because the items are tax deductible and thus may be written off.  They may not understand that deducting an item may result in tax savings, but does not make the item free. The following demonstrates how tax deductions work:

Suppose John runs a business.  During the year, John purchases $500 worth of tax-deductible paper for his business’s computer printer.  Assume no other deductions and no credits. Before the deduction, he has $10,000 of income.  His income tax rate is 30 percent.  If the paper were not tax deductible, his taxable income would be $10,000 and he’d pay $3,000 of taxes (30 percent of $10,000).  Because the $500 is deductible, however, his taxable income is $9,500 ($10,000 minus $500) and he’d pay $2,850 of taxes (30 percent of $9,500).

A “deduction” may be contrasted with a “credit,” which provides dollar-for-dollar savings. Thus, if in the above example the $500 was creditable as opposed to deductible, John’s taxable income would be $10,000 and his tax before the credit would be $3,000 (30 percent of $10,000).   Then, $500 would be subtracted as a credit from the $3,000, and he’d be liable for $2,500 in taxes.  The $500 credit thus would provide John with a tax savings of $500, in effect providing a $500 refund for the paper.

If you have any questions about these concepts, please contact me at 954-944-3929 or nrumbak@rumbaklaw.com.

*This document contains legal information, but does not contain legal advice.
*This document has examined laws in effect in July 2012

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