From the course: Finance for Non-Financial Managers
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Tax deductions and tax credits
From the course: Finance for Non-Financial Managers
Tax deductions and tax credits
- What is the impact of a tax deduction in our simple tax system? Let's say you make a hundred dollars. Remember, the first $50 is never taxed. The second 50 would be taxed at the 50% rate. So you pay $25 in tax. Now, let's say that of that $100 of income, you decide to spend $10 in a way that the government favors. Perhaps you spend $10 as a charitable contribution, or you spend that $10 paying mortgage interest on your home. So the government says, yeah, we want to encourage that behavior. That's a good way to spend $10. To encourage these behaviors, the government will give you a tax deduction for the $10 that you spend in this favorable way. So how does that $10 deduction enter into the payment of your taxes? Well, now you have to recompute your taxable income. You made a hundred dollars, but $10 you spent in a special way, which is tax deductible. So your taxable income is only $90. The first $50 is still tax free, and now the second $40 is taxed at the 50% rate. So you'll pay…
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