Isn't "I bought [blank] as a tax writeoff" complete nonsense?

Question

There's a trope in movies where people do something to keep from being bumped into a higher tax bracket (For example, in The Big Lebowski: "I'll have to check with my accountant, but it might bump me up to another tax bracket"). The thing is, that isn't how taxes work. This seems to be a financial version of "zoom, enhance, zoom, enhance..."

Similarly, I've seen dozens of movies/TV shows where people buy something "as a tax write-off", or "as a tax deduction". Sometimes they're cars or other expensive items, and sometimes they're donations. It seems the only reason they made that purchase/donation was for a tax deduction.

I didn't think that's how deductions worked. They don't save you money, they just reduce the money you've lost; they're a deduction of your taxable income. Is this another trope based on a financial inaccuracy?

To remove the movie aspect: Is a tax deduction ever a sole motivator for a purchase, or is it always just a "discount"?

Answer 1

I would say yes and no. I have spoken with people that don't want to pay off their home because they are getting a tax deduction on the interest. I've done the math for all of them and none of them are coming out ahead. The tax bracket reasoning is somewhat flawed because you don't pay 25% on all of your taxable income just because your marginal tax rate is 25%.

But there are times when a tax deduction could put you in a lower bracket and also allow you to get a larger tax credit for example. That would be especially worthwhile if your money went to something of value, like an IRA. Or maybe you were going to give $500 to charity, but then you do the math and realize that if you give $1000 instead, you'll get an extra $250 back on your taxes. That extra $500 donation only really costs you $250, so it's a tax write off, but it didn't really save you anything. That's an extreme example, but with a bracket, a credit or two and an itemized deduction, you might find a sweet spot.

Health expenses are deductible at a certain point. In a year when you've already had significant expenses, you may realize that you'll be able to deduct a portion on your next tax return. If your marginal tax rate was 15%, you could opt to get that laser eye surgery you've been wanting this year. It would cost you at least 15% less than if you waited until the next year. So it's a write-off, but you still have to pay the other 85%.

Business purchases could also allow for savings. For example, an LLC could sign a lease on a car and 'write it off' as a business expense. For the sake of simple numbers, say they pay a total of $25K over 3 years and this reduces their tax burden by $5K over that same period of time. The total cost to the business is $20K for 3 years. If the owner had entered into the same agreement outside the business, he/she would have spent $5K more overall. The 'write-off' didn't really help the business, but since the business and the owner are essentially the same, it was beneficial.

Sometimes, it's made to sound like tax write-offs are a simple way to get buckets of extra money or lots of free stuff. That part is nonsense. But there are real tax savings to be had by studying the deductions and credits and doing some good math. Some tax accountants specialize in minimizing tax burden and can give you some direction for your personal situation.

Answer 2

It is possible that some people may avoid additional income out of fear they may lose welfare benefits. If you currently have $30k of income and $5k of benefits, you might not want to earn an additional $3k if it would result in losing your benefits.

How common and significant welfare cliffs or poverty traps are is debated and political.

Answer 3

The idea of buying something as a tax write-off is that the asset that you buy reduces your tax liability by more than you paid for it. They are almost always artefacts of the tax code, intended to increase investment in some category. Generally tax authorities close the loopholes as fast as they become aware of them.

The closest thing to a tax write-off that I know of is my electric bike. It cost me $2,200 and reduces my taxable income by about $1,800 per year. It's not a true tax write-off because I actually have to use it, but it's a nice bonus, on top of being quicker than driving and far easier to park. The intention, I suppose, was to drive the adoption of electric vehicles by allowing an $.81/km deduction for business use instead of the $.73/km for petrol vehicles, but there's no check that the deductions claimed don't exceed the value of the vehicle.

As @Brian points out in comments, this only reduces my tax bill by $1,800 times my marginal tax rate (33%) so I will have to ride the bike for 4 years before it is totally taxpayer funded. At which point I will probably want a new one.

Answer 4

My family are farmers. My father needs a new farm truck. This year his income is higher than he is expecting for next year, thus he will buy the truck this year to get a better tax benefit.

My cousin had unexpected income one year, so he bought some equipment he needed. However the law at the time was that equipment purchased in the last quarter of the year could't be entirely expensed for that year. Thus he was not able to gain the full tax benefit as the next year his income was considerably less.

So if you are buying equipment you will need, but in a year where you have higher than normal income you can gain a tax advantage.

Answer 5

People do make tax-deductible purchases (and donations) which they might not have made if it hadn't reduced their tax liability.

If nothing else, it ought to be easy to see that what might be going on is they bought (or donated) more than they would have if the deduction hadn't made it cheaper to do so. A Lexus instead of a Toyota, for example, if it's justifiable as a business expense. Just because the way they talk about it is as simple as "I bought it as a write-off" doesn't mean that there isn't a lot more nuance behind the real situation.

Consider home buyers. If mortgage interest weren't tax deductible, there are lots of people who would buy 25% less house.

Answer 6

This answer is US focused.

In almost every case spending money only reduces your tax burden by your tax rate. If you are in the 22% bracket then spending $1,000 on a tax deductible item reduces what you pay to Uncle Sam by 22% of $1,000 or $220.

The exception is when spending the money earns you a 100% tax credit for spending the money. One example I know about is that the first $2,000 you spend on college tuition is a dollar-for-dollar tax credit. So it makes the most sense to pay $2,000 of the tuition bill each year from non-529 funds. The IRS will collect from you $2,000 less each year. Other examples might include other tax credits related to energy efficiency; though the rules, amounts, and deadlines change often so you would have to check the IRS website for details.

Another case where people want to write-off an expense is when they have to spend the money, but if they alter their method or make sure they can document it, then they will save on taxes. For example the IRS allows tax credits and deductions related to child care and medical expenses. If the taxpayer uses the flexible spending plans linked to their paycheck, or a Health Savings account, then they can reduce their taxes. Those plans/accounts have rules, and limits, but if you have to spend the money anyway then following those rules can save you money.

Answer 7

When it comes to healthcare subsidies with the Affordable Care Act, actually, this is how taxes work. If your income is 400% or less of the federal poverty level, the amount you pay on health insurance is capped at a percentage of your income; any cost beyond that is paid by the federal government as a tax credit. If your income is above 400% of the federal poverty level, there is no credit at all. This results in an income range tens of thousands of dollars wide in which you take home less net income than if you made slightly below the bottom of the range. Anywhere in that range, it's to your advantage to do something to get rid of the excess income to get back your subsidy.

Answer 8

There are certain credits and deductions that you can only take if your income is less than a certain amount, with no phase in/out. In those cases, it can be worth avoiding a small bump in pay in order to take a large tax credit/deduction.

Answer 9

No, the trope isn't "complete nonsense". Yes, people do sometimes focus solely on the tax-deduction aspect to justify purchases. Your Lebowski quote, however, seems to be talking about avoiding an additional amount of income due to the higher tax bracket.

I've heard someone say that they declined extra work because the additional pay would have bumped them into the next tax bracket, and he felt that the reduced after-tax pay for the incremental work wasn't worth the effort he'd need to put in.

Whether it's seeking a tax deduction or avoiding the next tax bracket, the psychology of the matter can't always be dismissed.

Answer 10

In a way taxes are there to give people benefit for proper expenses.

But people should not waste their money because they could write it off for taxes so to pay less taxes. In general for everyone it is wise to have as little as possible expenses so that the profit is high. Higher profit also means higher taxes but at the end it is always more than with expenses.

Let's make an example: A person has an income/profit of 90.000 EUR and has to pay 45% taxes. So taxes are 40500 EUR. Thus his income after taxes is 49500 EUR.

The person wants to buy two monitors, 500 EUR each which is considered a writeoff. Now his profit is 89000 EUR. Taxes are now only 40050 EUR (450 EUR less than before). His income after taxes is 48950 EUR (550 EUR less than before).

So after buying the monitors the person ends up 550 EUR less than before but having two monitors.

There is no tax bracket which helps to change this scenario, no matter if the tax percentage is 10%, 20%, 30%, 40% or 50%, just the numbers are different. With spendings you always end lower than without spendings.

Answer 11

I think this is similar to any other time you might take action to lower your taxable income, like putting more into an IRA or 401k. For me, the biggest reason I might want to lower my taxable income with tax write-offs, IRAs, etc. has to do with escaping capital gains tax.

For example... Let's say a married couple are bringing in a taxable income of $77,400, but are sitting on long term capital gains of $2,000. If they were to sell their shares now, they would have to pay 15% of their earnings = $300. However, if they can find some way to "write off" up to $2,000 worth of expenses, not only will they save 12% in taxes on the thing they are writing off, but they will also avoid the capital gains tax entirely if they realize their capital gains. This adds up to a "savings" of $540, or 27% of that $2,000 write off.

The point is that purchasing or donating whatever you are going to write off may not seem worth it at full price, but if you can get a 27% discount, then you might decide it seems worth it.

Answer 12

The only common thing I can think of is that there are situations where earning more income would subject you to the Alternative Minimum Tax (AMT). The rules around this are complex and, if I'm not mistaken they have changed this year with the new tax law.

An alternative minimum tax (AMT) recalculates income tax after adding certain tax preference items back into adjusted gross income. AMT uses a separate set of rules to calculate taxable income after allowed deductions. Preferential deductions are added back into the taxpayer's income to calculate his or her alternative minimum taxable income (AMTI), and then the AMT exemption is subtracted to determine the final taxable figure.

I don't pretend to understand the details but this can lead to a situation where a small increase income can trigger relatively large increase in taxes such that you end up with less post tax income. Avoiding AMT is always preferential. I don't know whether you can buying things to get a deduction to avoid this. Part of AMT is eliminating some deductions.

Answer 13

It probably doesn't apply to personal taxation situations, but there are cases where you can purchase an unprofitable corporation with accumulated and unused losses and use those to reduce the corporate tax of a profitable corporation.