A common misconception I hear people say regarding certain expenses or giving is, "it's okay, I'll get it all back at tax time." Well, that's not exactly true and, strictly speaking you do not "get it back" at all. So what does a deduction do...
How do deductions work?
A tax deduction reduces the amount of income you have to pay tax on. The Tax Office does not reimburse you for your expenses nor can you deduct these from your tax amount. Tax deductions are taken off your total income to get your 'taxable income' - the amount your tax is calculated on.
Income - Deductions = Taxable Income
Example:
Sally has income of $25,000. The tax payable on this amount is $2,850. Now suppose that Sally also has $400 in deductions. This reduces her taxable income to just $24,600. Tax payable on $24,600 is $2,790.
In this example, deductions of $400 have saved Sally $60 in tax (Sally is taxed at the 15% tax rate).
Please note this is a simplistic example given as a guide to understand how the deductions work and does not take into account other factors such as offsets previous losses, the Medicare levy, etc.
How much of a saving?
The individual tax saving as a result of deductions will vary depending upon what tax bracket a person is in. If your taxable income is less than $6,000 you would not receive any benefit from a deduction as your income is below a taxable level.
As the average Australian is in the 30% tax bracket, the best most of us can hope to recoop of our allowable deductions is just 30 cents in the dollar; better than nothing but a long way from "getting it all back at tax time."
2 comments:
A further definition of both 'deductions' and 'offsets' or 'rebates' can be found in the article Terms of endearment - Part 1 at Dollars & Sense for Small Business.
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