Pay more, deduct more

By MARY HOLM

Q: I am almost 80 years old and have tried most types of investment. Still learning.

Would you please elucidate on the letter in a recent column where you rightly criticise the financial adviser for suggesting that the 52-year-old widow with no dependants should borrow $100,000 to invest.

You write, "In the 33 per cent tax bracket, every dollar you spend on interest - or any other tax-deductible expense - still costs you 67c."

Your answer is probably just simply arithmetic, but I just cannot get my head around it.

Probably a few thousand other readers of your column are somewhat bewildered.


A: I couldn't bear the thought of all of you out there scratching your heads. The dandruff could get bothersome. So here goes.

Let's say you have $1000 of taxable income. If you're in the 33 per cent tax bracket, tax on that will be $330.

Now let's say you spend $100 on any tax-deductible expense. Perhaps it's interest on money that you've borrowed for an investment, or rates on a rental property.

On your tax return, you subtract the $100 expense from the $1000, to give you $900 of taxable income.

The tax on $900 will be $297 (33 per cent of $900).

Because you deducted the expense, you've paid $33 less in tax ($330 minus $297).

You've spent $100, but the net cost to you is $67.

And it is proportionate on other amounts. If you spend $1, the net cost to you would be 67c. On $100,000, it would be $67,000.

Another way to think of it: If you spend $100 on something tax-deductible, that cancels out tax on $100 of income.

That tax saving partly offsets your spending.

Fortunately, you don't have to think through all these steps all the time. Simply subtract your tax bracket from 100.

* In the 19.5 per cent bracket (taxable income less than $38,000), 100 minus 19.5 is 80.5.

Every time somebody in that tax bracket spends money on something tax-deductible, it ends up costing them 80.5 per cent of the amount spent, after tax.

* In the 33 per cent bracket (taxable income of $38,000 to $60,000), 100 minus 33 is 67.

For people in this tax bracket, tax-deductible spending costs them 67 per cent of the amount spent, after tax.

* In the 39 per cent bracket (taxable income more than $60,000), 100 minus 39 is 61.

For people in this bracket, tax-deductible spending costs them 61 per cent of the amount spent, after tax.

Higher-income people get more mileage out of tax deductions, but that's simply because they pay more tax.


* Got a question about money?

Send it to:

Money Matters

Business Herald

PO Box 32, Auckland

or e-mail: maryh@pl.net.

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