How Do Tax Write-Offs Work?

Unlimited415 said:

the amount that you write off gets sliced off your total income for that year, so the hope being you write enough off to put you into a lower tax bracket?

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i'm 95% sure this is how it works.

This is a question with a myrid of answers. Different deductions (IRS term for "write off") work different ways. The tax code is filled with deductions that are documented in volumes of tax code. The most familiar example, however, is the standard deduction, which everyone gets for "free," out of the goodness of the IRS's collective heart. Even the standard deduction, however, isn't that simple, and is subject to some limitiations. Namely, if you choose to itemize deductions, you lose your standard deduction.

Though most that I am familiar with work the way you describe, the beauty of write-offs is that you can write-off many NECESSARY expenses. A good example is a retirement account (IRA, 401k, 403b.) This is a form of savings (which you should be doing anyway) that is tax deductible (you "write-off" your qualified contributions to a retirement account.)

Unlimited415 said:

Anyone know exactly how tax write-offs work?

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This is how they work. If you are in a very high tax bracket, you'll save about 35 cents for each dollar of deduction you can come up with ABOVE the standard deduction. The first $10,700 basically doesn't count.

Even if you can't deduct enough to get into a lower tax bracket, it still helps reduce taxable income. I'm keeping my 2007 IRA as "traditional" and won't covert to a Roth until 2008 cuz I wanna deduct an extra $4k and hopefully get into a lower bracket. I think there's some deductions that one can use in addition to the standard deduction without having to itemize. IRA/401(x)/Education credits/student loan interest I think, but I'll have to check on it.

Dallenoff said:

Even if you can't deduct enough to get into a lower tax bracket, it still helps reduce taxable income. I'm keeping my 2007 IRA as "traditional" and won't covert to a Roth until 2008 cuz I wanna deduct an extra $4k and hopefully get into a lower bracket. I think there's some deductions that one can use in addition to the standard deduction without having to itemize. IRA/401(x)/Education credits/student loan interest I think, but I'll have to check on it.

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Yes, you can use any "above the line" (deductions that modify AGI, not taxable income) deduction without giving up your standard deduction. These all appear on page 1 of form 1040 and inclue things like qualified moving expenses, as well as student loan interest, and a deduction for [traditional] IRA contributions, as you mentioned. There are others too (that I don't remember mostly because they have never applied to me.) Oh, I think some childcare exepnses can be taken above the line, as well.

By far, most deductions are taken below the line (after AGI is computed) and you have to give up your standard deduction to take them.

That's why my first answer was kind of weasel-ly There are just so many deductions out there that there is really no succinct way to describe how they all work. Hence, the volumes of tax code/documentation that exist.

Deductions are used to lower your taxable income. Most people take the standard, which is roughly over 5K or you can chose to itemize- which requires filling out a Schedule A form, keeping VERY close track of job-related expenses you paid for, use of your car for your job, travelling for your job, state income taxes, charitable donations, etc.... there are a ton of things which one can deduct.

There are some extra deduction you can take (student loan interest and retirement account investments are examples) on top of taking the standard deduction or itemizing.

Credits are taken off of your calculated tax payment. As noted above a $100 deduction would probably cut you $35 off your taxes. But a $100 credit would cut out $100 from your taxes. The only one I can remember is using hybrid vehicles.

Another important business deduction is using shcedule C. Especially if you do some moonlighting and/or self-employed. Self employment income taxes you another 15% on TOP of the 25-35% you would pay from regular income (something to do with social security and medicare taxes). The beauty of it though is many "itemizable" deductions can be written off as business expenses. Books, educational expenses, going to medical conferences, licensure, transportation costs, cell-phone, computer costs, internet costs, etc. can all be deducted rather easilly from your self-employment income- avoiding a lot of that huge tax. It also leaves you the option of taking the "standardized" deduction on top of all those business expenses.

Nardo

Bernardo_11 said:

The beauty of it though is many "itemizable" deductions can be written off as business expenses. Books, educational expenses, going to medical conferences, licensure, transportation costs, cell-phone, computer costs, internet costs, etc. can all be deducted rather easilly from your self-employment income- avoiding a lot of that huge tax.

Nardo

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One needs to be very careful about deducting business expenses. Many things that you would think are deductible (USMLE expenses) actually are not deductible when you read the regs (or publications). There's also a 2% floor on business expenses. This means that you cannot deduct the first 2% of you AGI ($2,000 for someone earning $100,000) for those expenses.

I also want to correct a common misconception that people have about tax brackets. They are graduated, not flat. To explain, I'll use an example: Suppose there are only two tax brackets 10% and 20%. The brackets are graduated at $50,000. If you make $60,000, you pay 10% or $5,000 on your first $50,000 and 20% or $2,000 on the next $10,000. You do not pay 20% on the full amount. Thus, one needn't worry too much about "getting down to a lower bracket" or worry about making too much money which lifts them up.

Ed

edmadison said:

One needs to be very careful about deducting business expenses. Many things that you would think are deductible (USMLE expenses) actually are not deductible when you read the regs (or publications). There's also a 2% floor on business expenses. This means that you cannot deduct the first 2% of you AGI ($2,000 for someone earning $100,000) for those expenses.

I also want to correct a common misconception that people have about tax brackets. They are graduated, not flat. To explain, I'll use an example: Suppose there are only two tax brackets 10% and 20%. The brackets are graduated at $50,000. If you make $60,000, you pay 10% or $5,000 on your first $50,000 and 20% or $2,000 on the next $10,000. You do not pay 20% on the full amount. Thus, one needn't worry too much about "getting down to a lower bracket" or worry about making too much money which lifts them up.

Ed

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Hmm... never heard of that 2% floor. Do you know which publication has that information. I always thought schedule C deductions could be anything considered "usual and necessary" to run your business. For my 2006 return, the deductions were made without consideration of this floor... I haven't heard from the IRS yet, but got my return check just fine. Please no audit. Please no audit.

Good point with the graduated tax.

This reminded me of a Seinfeld episosde where Kramer tells Jerry that its just a write off for them and Jerry goes what do you mean its just a write off, and Kramer goes...Jerry - they just write it off. Jerry looks at him and goes - you dont even know what that means do you? hahahah

Bernardo_11 said:

Hmm... never heard of that 2% floor. Do you know which publication has that information. I always thought schedule C deductions could be anything considered "usual and necessary" to run your business. For my 2006 return, the deductions were made without consideration of this floor... I haven't heard from the IRS yet, but got my return check just fine. Please no audit. Please no audit.

Good point with the graduated tax.

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Ah okay, did my own research. From what I've read, the 2% floor applies only to individuals deducting employee/business expenses from Schedule A along with the rest of their itemized deductions. The floor though does not apply to Schedule C. Whew!!

Bernardo_11 said:

Ah okay, did my own research. From what I've read, the 2% floor applies only to individuals deducting employee/business expenses from Schedule A along with the rest of their itemized deductions. The floor though does not apply to Schedule C. Whew!!

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That's right. This isn't directed at anyone in particular, but if you are not 100% sure about information that you post, you shouldn't post it. Like I mentioned above, the tax code is exceedingly complex (as evidenced by this confusion between business and work expenses,) so there is no easy answer to how "write-offs" work. Most of the tax code is devoted to explaining how each particular deduction (= write-off) works.

Bernardo_11 said:

Ah okay, did my own research. From what I've read, the 2% floor applies only to individuals deducting employee/business expenses from Schedule A along with the rest of their itemized deductions. The floor though does not apply to Schedule C. Whew!!

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Very good point. Thank you for the distinction. Many, if not most people reading this will be employees (certainly non-moonlighting residents will be) and thus deductions under schedule A are the norm (and this is what I was referring to). Those who are independent contractors, sole proprieters or partners in a practice will use schedule C and its rules. One needs to be very careful about deducting things for business expenses that are also for personal use. This is where many get into trouble. Also, durable items often must be depreciated rather than written off in one year. Scheudle C is quite complicated and if you are contemplating its use you'd best know what you are doing or hire someone who does.

Ed