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General tax-related question, here.

Let's say I do freelance work and need to buy special software or equipment to do that work. When I claim that work as income and pay taxes on it, I know that I can also deduct the cost of the software and equipment in certain cases (and yes, I'll talk to an accountant).

But how does that work?

I guess my question is, generally speaking, what is the net result for me as it pertains to the cost of that software and equipment after I claim? Am I reimbursed the cost of those items, fully or partially? Only the tax I paid on those items?

  • I edited to add country tag based on your user info, please correct if I'm wrong. – BrenBarn Apr 5 '14 at 17:50
  • It will reduce your tax amount by the depreciation of the equipment and/or cost of the software. There are two ways to take your deduction, all in one shot or over 5 years. – GµårÐïåñ Apr 5 '14 at 18:52
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You're not reimbursed for those particular items in any way. You just get to deduct the cost from your income. For example, if you pay $100 for a piece of software, you must have gotten that $100 as income somehow. Roughly speaking, the tax writeoff means you get to pretend you never earned that $100 as income in the first place.

How much money you save from this depends on your marginal tax rate. The higher your tax rate, the more you would effectively save. For instance, if you were in the 25% tax bracket, then earning an additional $100 would mean you must pay $25 in taxes. So if you get to deduct that $100 and not count it as income, you effectively save $25 by not having to pay tax on the $100.

You "save" this money only in the sense that you don't have to pay it in your tax bill when you otherwise would. No one writes you a check reimbursing you for the $100 you spent. It just means your tax bill will be slightly smaller, or your refund slightly larger.

This is the basic idea, but I'm glossing over a lot of complications here. There are various restrictions on when you can or can't deduct a certain expense, and in some cases you can only deduct a portion of the expense, so paying $100 on a work expense may not actually reduce your taxable income by $100. But the idea is the same: your effective savings are a percentage of what you get to deduct from your income, and that percentage is larger the higher your marginal tax rate.

  • Thank you. I'm very much in the dark about all of this. This all makes sense. – Aaron Apr 5 '14 at 18:00

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