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"?

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    Define "nonsense" - are you asking if it actually saves anyone any money ever, or, are you asking whether people are ever motivated to incur other expenses specifically to avoid paying taxes? – Beanluc Sep 19 at 22:27
  • Buying legitimate stuff for a tax write-off is legitimate, though you don't often save more on taxes than you spend. Buying nonsense stuff for a tax write-off is just spending less stuff on nonsense than otherwise, essentially buying junk on sale if you will. What is legitimate and what is nonsense is subjective though... – Spoki0 Sep 24 at 6:25
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    I think this was much more true in the 50s-80s, tax brackets were steeper and many, many more things could be written off. – Bill K Sep 25 at 16:28
  • Some business or hobby expenses can be written off in their entirety. A musician can make money and either spend it on deductible expenses such as a new instrument or supplies or realize it as profit and pay taxes on it. Also, if you're in that 0% tax bracket, living off of savings, and earning less than the standard deduction, it's important to consider tax consequences of say profiting from selling stock or a part of a retirement account. – frayser Sep 26 at 9:36

13 Answers 13

up vote 97 down vote accepted

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 to you 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.

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    There are good arguments for paying off your mortgage last, and even for keeping your mortgage when accumulating other assets to reduce the risk of having all your net worth in one property, But "paying an extra 3 dollars to the bank so you can pay 1 dollar less to the IRS" is the one people seem to like. – Rupert Morrish Sep 20 at 1:40
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    This is not necessarily right. Where I am from, interest is deductible from earnings for taxing. Which means at at my rather aggressive tax bracket (45%) - the government is paying for 45% of it. Most of my salary is at a different tax bracket (somewhere around 35%). So, a 2.5% interest rate becomes a 1.3% effective interest rate - which both less than inflation and certainly less than CPI's for housing where I live. So, parts of my mortgage are in effect free capital. – Stian Yttervik Sep 20 at 10:28
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    Thank you for covering the mortgage deduction. My mom did taxes and beat that into our heads from an early age. The colloquial everyman explanation goes something like this, "You'll lose the deduction and owe the government an extra $100 in taxes, but you also won't have to pay the bank $1000 in interest". – Freiheit Sep 20 at 12:55
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    My mortgage is 3.75% interest, if I get a tax deduction for the interest and I invest the money rather than paying off the mortgage I'm almost sure to come out ahead (even with fairly low yield investments). – xyious Sep 20 at 16:16
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    I'm the one who doesn't want to pay off the home because of the tax deduction. I can make my mortgage rate on the stock market in the worst year I've been through (that was 2009). – Joshua Sep 20 at 16:39

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.

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    Here's a link to a study (in German, about Germany) looking at the marginal rate of tax + social insurance + social wellfare transfers. It found a few such wellfare cliffs where more gross wage in fact leads to lower net payments. – cbeleites Sep 21 at 17:27
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    @cbeleites, in Germany, is the income that determines welfare eligibility before or after charitable contributions? Could someone become eligible for $X of welfare by making a contribution to charity of $Y, with X > Y? – Charles Fox Sep 21 at 18:54
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    Many years ago, you could deduct 5% of the purchase price of a new home for 8 years in Germany. That is if your income was less than DM 130,000 (I said many years ago) or 260,000 for a couple. If your income was 129,000 it made a lot of sense to refuse a raise to 132,000 for example. – gnasher729 Sep 21 at 20:25
  • @CharlesFox: AFAIK no: IIRC wellfare considers gross income minus what may roughly be described as unavoidable expenses (tax, social insurance, a few more insurances, costs for e.g. commuting to work). Special expenses such as charitable donations don't enter there. However, these rules are so intricate that I wouldn't claim positive knowledge... And while some of these situations have a plateau where additional income is entirely deducted from eligible wellfare, at least one of the spikes where more gross leads to less net income does have an absolute size < 10 €/month because... – cbeleites Sep 21 at 20:38
  • if it turns out someone is eligible for between 0 and 10 € of housing wellfare per month, that is not paid out. – cbeleites Sep 21 at 20:40

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.

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    The $2200 vs. $1800 figure is misleading. Assuming your effective tax rate is 20%, you spent $2200 to save about $360 at tax time -- break-even point is in year 7, assuming your tax rate and riding amount don't change much. – Brian Sep 20 at 16:48
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    The government isn't paying him anything, the taxpayers are, which is somewhat uncool if you think about it - I don't want to pay for some dude's lame electric bike. – Callum Bradbury Sep 20 at 16:49
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    @CallumBradbury the taxpayers aren't paying him anything, the government is allowing him to keep a bit more of the money he already earned. – Kevin Sep 20 at 17:53
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    @Kevin from an economics standpoint, the money that he doesn't pay in taxes either has to be made up somewhere else (someone else's tax money) or leads to less funding for something the Gov't provides through taxes (loss of utility for each taxpayer). From a reality standpoint, each credit/deduction generally just raises the national debt. – GOATNine Sep 20 at 19:09
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    @CallumBradbury The idea is that he will use the his car less and as a result wear out the road less (generate less harmful waste that needs to be cleaned up) (make him healthier thus is less of a drain on medicare). The idea of paying people to change behavior is so that in the long run there is a net positive effect for the tax payer. – Martin York Sep 21 at 0:30

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.

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    But then you are not "buying it as a tax writeoff", but "moving the purchase to this year for tax optimization purposes". I don't think that fits the question. – mastov Sep 21 at 9:30

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.

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    In Australia mortgage interest is not deductible unless it is for an investment property, that doesn't stop many people from purchasing the biggest or most expensive house they can afford and borrow to their max. – Victor Sep 19 at 23:01
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    Sure - I'm saying they can afford more if there's a tax break. – Beanluc Sep 20 at 0:51
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    I'd have to chase a good source for this, but I believe the house price example is plain wrong. The problem is that housing is an inelastic market. Production is fairly small and slow. Most sales are second-hand. Without a tax deduction, the market size would therefore not be affected. People would still be buying the same houses. However, they would be buying the same houses for 25% less money. – MSalters Sep 20 at 6:56
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    @MSalters You're ignoring the buy/rent cutoff there, though. More people would rent, not buy, if there weren't a deduction for the interest. (Whether that's something the government should be incentivizing is a very different question.) – Joe Sep 20 at 15:18
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    @MSalters There's definitely some truth to what you say but I think it's a bit more complicated. Since the deduction effectively lowers your interest rate, you can borrow more. This matters when you build a home since the cost of labor and materials doesn't change due to housing demand. Newer homes tend then to be larger that they would otherwise. This has some impact on the value of existing homes. The result is that we all end up having bigger houses than without the deduction. I that has been shown in economic studies IIRC. – JimmyJames Sep 20 at 18:58

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.

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    Minor correction to the first paragraph: that only applies as-is if you are more than 1,000 USD above the bottom limit of the 22% bracket. If you are below that, only the amount that pushes you above the bracket is taxed at 22% and everything below that is taxed at the rate of the bracket below. – Nzall Sep 20 at 10:45
  • "One example I know about is that the first $2,000 you spend on college tuition is a dollar-for-dollar tax credit." This is income-dependent, though, right? I seem to recall that I was never eligible for this, as my income was too high. I could take a deduction for college expenses, though. – reirab Sep 20 at 15:47
  • There are two options for the tuition break. One is a deduction, the other is a credit. Eligibility rules differ. – WGroleau Sep 22 at 11:35

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.

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    "[T]he federal poverty guidelines in 2018 were ... $12,140 for an individual and $25,100 for a family of four." -Source So those ranges are from $48,560 to where-over 68k?, and $100,400 to where-over 120k?, etc? – Matthew Elvey Sep 25 at 1:27
  • @MatthewElvey: That's pretty close to what I expected. I didn't want to do the math and get it wrong, but by 2017 numbers it was something like $98k for a family of four, up to that plus insurance premium, which could easily be over $30k. – R.. Sep 25 at 2:48
  • @R: My comment is more of a question... seeking confirmation (from you) that that I understood you - that the income ranges tens of thousands of dollars wide you refer to exist and/or information on how wide they are. – Matthew Elvey Sep 28 at 20:21
  • @MatthewElvey: I think the values in your comment are roughly correct. The bottom of the range depends purely on the federal poverty level for your family size; the width depends on the cost of the second-lowest-cost silver plan (SLCSP) in your zip code for the ages and smoker-status of your family members. I had a link to a site that would help you figure out your premium & subsidy anonymously, and it was very easy to experiment with income figures and see what happens, but I forget what it was. If I find it again I'll post it. – R.. Sep 28 at 22:49

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.

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.

  • "reduced after-tax pay" The calculation of whether increased work hours are worth the money exists at all income levels. The marginal tax rate on the money is just one consideration. – Rupert Morrish Sep 20 at 1:46
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    @RupertMorrish For the individual I mentioned, the marginal tax rate was his stated consideration - which is why I mentioned it. – Lawrence Sep 20 at 5:31
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    Yeah, it may not be nonsense to suggest that people do sometimes make purchasing decisions because of the tax deduction, but the decision itself is still nonsense if that's the sole reason. Even if you manage to knock your marginal rate down to the next-lower tier with a deduction, you would have only been paying the higher marginal rate on the portion of your income over that bracket's threshold, so you still will only recover purchase cost * marginal rate from tax benefits, which is guaranteed to be less than the purchase cost. – reirab Sep 20 at 15:45
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    @Lawrence - Especially in the higher income brackets. I have read that surgeons will stop work at certain income because taking home(after taxes) say$400K vs $300K, a difference of $100K, requires $200K more in earnings because they will be pushed into a much higher bracket. – paulj Sep 20 at 17:39
  • @paulj Exactly! – Lawrence Sep 20 at 22:25

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.

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    Then again, they have 550 EUR less and two monitors more - so in effect the monitors became cheaper (275 instead of 500 each) – Hagen von Eitzen Sep 23 at 16:41
  • Yes, right. If the two monitors are of good use then it is fine to pay effectively less for them because of the deduction. If the monitors are of no use then buying them just to get "the tax deduction" would be nonsense. Or if 150 EUR monitors would be fine as well (which would also result in a tax deduction, but a lesser one) it would be better to go for them. – michaeak Sep 25 at 7:15

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.

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.

  • If we take it to an extreme where all of the couple's income is from long term capital gains, then if they exceed $77,400 in income, they go from paying 0% in taxes to 15% in taxes. In which case, donating all excess income between $77,400 and $91,000 would result in a tax savings in excess of the amount donated. – Kora Sep 24 at 16:02
  • @Kora sorry that's wrong. You would still only be taxed for the gains that exceed $77,400, so if you brought in $79,400 in capital gains, then only $2,000 would be taxable. – BlackThorn Sep 24 at 17:38
  • from my understanding, Capital Gains taxes are all or nothing; not marginal. I can't seem to find a source from the IRS though. fool.com/taxes/2018/09/21/… – Kora Sep 24 at 18:52
  • @Kora Fortunately, a little spillover into the 25% bracket will not make the entire gain taxable at the higher marginal rate. source – BlackThorn Sep 24 at 20:18

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.

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    ... which will most probably still only make sense if there's some future value to be found in that acquisition or at least can be got rid of without creating further liabilities. Otherwise, if it goes on to be unprofitable, you're going to loose. Or, the other way round: an unprofitable business that does offer positive gain via unused losses and no (too bad) liabilities has a positive value which is likely to be close to the purchase price... – cbeleites Sep 21 at 20:51

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