THE VALUE OF A TAX DEDUCTION - MORE THAN YOU MAY THINK

An interesting development worth discussing.  This is something that should be considered when doing year-end tax planning in a year you had qualifying dividend and capital gain income.

A client had substantial capital gains for 2018 which were taxable at the lower capital gains rates.  A portion of the capital gains were taxed at 0% while most was taxed at 15%.  The client’s “ordinary” income was taxed at the 12% marginal tax rate.  If we disregard the capital gain income – if all his income had been taxed as ordinary income - the client would have been in the 24% marginal bracket.

After I had done an initial write up and tax calculation the client told me about an additional $350 non-cash contribution to the Salvation Army he had failed to include when sending me his stuff.

This additional $350 reduced his net taxable income and therefore reduced his “ordinary” income tax by $42 - $350 x 12%. 

But the $350 reduction in net taxable income also allowed an additional $350 of his capital gains to be eligible for the 0% rate, so $350 less in capital gain income was taxed at 15%.  He reduced his tax liability by another $52.50 - $350 x 15%. 

The bottom line - the additional $350 deduction saved him $94.50 – or 27% - in federal income tax.

As we can see, because of the different rates for different types of income the savings from a tax deduction can be more than the ordinary marginal tax rate.  In the above example the savings was more than twice this rate.

This example involved a “below the line” tax deduction, the “line” being AGI.  Deductions allowed “above the line” can generate even more savings by reducing the amount of other deductions or credits that are phased-out based on AGI and reducing the amount of taxable Social Security or Railroad Retirement benefits.

This is something that should be considered when doing year-end tax planning in a year you had qualifying dividend and capital gain income.

TTFN