“So, what can I purchase to get a tax deduction?” According to my associate, CPA Kevin Lin, “This is a common question taxpayers ask when they have the itch to spend indiscriminately, especially at tax time.” The attitude is that by spending, they’re really getting something at a bargain or almost free because the deduction reduces their taxable income. So, they buy something they wouldn’t usually buy to get a tax deduction.
There are two other popular ways to reduce your taxes. Tax credits reduce your income tax liability dollar for dollar. Taxpayers can also take advantage of tax rebates through government initiatives and certain purchases. Let’s examine how deductions, credits, and rebates can save money.
DEDUCTIONS – Tax deductions reduce your adjusted gross income for calculating your taxable income. Above-the-line deductions are subtracted from your gross income to calculate your adjusted gross income (AGI). Below-the-line deductions are subtracted from your (AGI) to calculate your net taxable income. An example of an above-the-line deduction is your IRA contribution. If you’re a single individual with $75,000 earned income and contributed $6.000 to your IRA, your AGI would decrease to $69,000. Then, below-the-line deductions reduce your AGI, such as a surgery medical expense of $10,000 lowers your taxable income to $59,000. Above-the-line deductions include business expenses, pension contributions, and health insurance premiums self-employed individuals pay. Below-the-line deductions include medical costs, state and local taxes, and charitable donations.
CREDITS – Tax credits reduce your tax liability dollar for dollar. However, in most cases, tax credits cannot reduce your tax liability below zero. Common credits are Child Tax Credit, Dependent Care Tax Credit, and Education Tax Credit. Unlike regular credits, the low-income refundable tax credit (LITC) and Health Coverage Tax Credit (HCTC) can be refunded even if the credit is more than your tax liability.
REBATES – Federal Tax rebates are another way to save money on purchases. State and municipal governments sometimes administer the issuing of federal rebates. An example would be when the City of Long Beach, California, offered rebates of up to $500 to encourage solar water heater purchases. Local government rebates differ depending on certain initiatives. Other examples are hybrid car tax rebates and economic stimulus initiatives.
Taxpayers often spend without knowing their purchase’s impact on their personal income and taxes. For instance, if you’re in a 20% tax bracket, does it make sense to buy something you don’t really need for $10,000 just because it’s tax deductible? You’ll save $2,000 on taxes, but you’ll still be out of pocket $8,000. So, you must ask yourself if what you bought was an $8,000 bargain.
Rather than purchase indiscriminately, it’s better to plan tax-sensitive purchases in advance and see how they will impact your taxes. Many try to save money by doing their own taxes, but while you save money on that end, you may be losing more than you save. Consider working with a tax professional who can keep you updated on ways to save on taxes.
If you already have an investment and tax advisor, congratulations. However, if you’d like to learn more about what investment and tax advisors do for their clients, don’t hesitate to contact me or my associate, Kevin Lin, at empiriKalpartners.com for an individual assessment. Have a happy and prosperous 2023!
Edward Vela is an Investment Advisor and Estate Planning Specialist at empiriKal partners, llc©, with 15 years of wealth management experience. He earned a Journalism Certification from the University of Massachusetts, a BA in Political Science, a Financial Planning Certification at UCLA, and an MBA from the UCLA Anderson School of Management. You can contact Edward at 925-300-8805 or email edward@empiriKalpartners.com.
