How Do Tax Deductions Work?

“It’s okay, I’ll get it all back at tax time.” You know, I hear people say that all the time and I want to pull my hair out (yes, I really am that anal). See, it’s not exactly true and, strictly speaking you do not “get it back” at all.

So what exactly does a tax deduction do for you… ?

 

 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 very 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 $14,000 (after 1 July 2008 with the low income offset) 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.”

* The rates provided in examples and explanations are current at the time of writing but are subject to change each financial year.

This information is for guidance only and is not intended as specific advice to any reader. Professional advice should be obtained before acting on any information contained herein. The publisher accepts no responsibility for loss occasioned to any person or organisation as a result of action or the refrain of action as a consequence of the contents of this publication.