As we’ve discussed in previous blogs, the world of tax is confusing and full of misunderstandings and misinformation. This week’s blog will try and alleviate some of the most common misconceptions that people have around taxes and specifically, tax deductions.
First off, let’s clear up what tax deductions even are.
A tax deduction is an amount that reduces taxable income. Under current tax law most people take the standard deduction on their tax return. This is a fixed amount that the government allows for each taxpayer, regardless of income, to reduce their taxable income by.
For tax year 2024, married couples are able to reduce their taxable income by $29,200, a single filer gets half of that - $14,600.
The other way to reduce taxable income is through itemized deductions. Taxpayers that incur significant deductible expenses throughout the year will prefer to use this method. Common examples are mortgage interest, state and local taxes (capped at $10,000), and charitable contributions (these come with different types of limitations based on what you’re donating).
To gain any benefit, your total itemized deductions must usurp the standard deduction. For example, if I have $10,000 of mortgage interest, $5,000 of state and local taxes, and $5,000 of charitable contributions while filing jointly, none of those expenses reduce my taxes federally. The standard deduction of $29,200 is more than $20,000.
Let’s say you had another $10,000 in charitable contributions bringing your total itemized directions to $30,000 - this would decrease your taxable income by only $800 compared to the standard deduction.
Your taxable income is not the same as your total tax. A tax credit is not the same as a tax deduction, either. A tax credit is usually a dollar for dollar reduction of tax - some are refundable, some are non-refundable. Your taxable income is what is used to determine your tax. Oftentimes, your tax deductions will reduce your total tax at your highest marginal tax rate.
For instance, you and your spouse have income of $250,000. This places you in the 24% tax bracket in 2024. Let’s apply the standard deduction of $29,200.
The standard deduction reduces your taxable income to $220,800 - this effectively saves you $7,000 in taxes. ($29,200 x 24%).
If you were to drop to the 22% bracket because of your deductions, your savings would be at a blended effective rate.
People most familiar with tax deductions are business owners. Each reasonable and ordinary expense their business has will reduce their taxable income by the same amount. There are few limitations to this, but that is the typical standard.
Now that we know what tax deductions are, and how they impact taxes, let’s talk about the 8 most common things people think are deductible, but really are not.
Taking a client out to a show or a ballgame is not deductible. It can be an effective way to market yourself to that person, but it will not save you a dollar on taxes. From concert tickets to golf, none of it is deductible.
Similarly to entertainment expenses, just because you do 100% of your networking at the course, none of that is deductible on your tax return. Not much to say beyond this. One thing to note - if your business pays for a meal at the clubhouse and that’s with clients for a business purpose, you can get a 50% deduction for that meal. Your dues will not offer you a deduction or tax benefit.
One of the most common tax deductions for self-employed individuals: the mileage deduction. While it is true you can deduct $0.67 per mile driven in 2024, where you’re going matters for the purposes of this deduction.
A trip from your home to your primary location of work does not count for the deduction. So your daily commute gets you nothing in terms of tax savings.
This is one I keep seeing on TikTok or YouTube Shorts. There are limited cases where clothing is going to count for a deduction. Protective equipment for a construction job could be considered deductible. If you buy a new suit because you want to impress a client in an upcoming meeting, this isn't going to count.
Two good questions to ask yourself when considering whether clothing or uniforms would be deductible are:
When you think of clothing deductions, think protective eyewear, hard hats, and safety boots. Don’t think of Prada, Versace, or Gucci.
This one is more complicated than people may think. If your business is on the cash basis and you don’t track your inventory, you may be able to deduct material purchases when you purchase them. Granted, this applies to small businesses only - meaning less than $25,000,000 in annual gross receipts.
However, if you are tracking inventory and you are on the hybrid method or accrual basis, you are prevented from doing this. Many people will think it’s a good strategy to buy up a ton of inventory year-end to reduce taxable income. However, under the accrual or hybrid method you don’t recognize the cost of goods sold until the inventory assets are either consumed or sold.
Therefore, you’d be engaging in a transaction that simply reduces your cash position, but not your taxable income. Inventory is an asset, not an expense.
For more information on this, check out the Tax Advisor’s journal post on this here.
For the most charitably inclined among us - you may choose to give your most valuable asset rather than money: time. Unfortunately from a tax perspective, this won’t benefit you.
Even if you’re representing yourself as a consultant with an hourly rate of $10,000 per hour, the time you donate to a charity gets you exactly $0.00 in tax savings. Don’t let this discourage you from donating your time, but just know, your tax preparer is going to disregard those materials.
Travel for strictly business purposes IS deductible. However, that conference in Hawaii does look like a promising opportunity to extend into a vacation, does it not?
Any portion of the trip done for personal reasons and pleasure is not deductible. So the moment you extend the stay from the duration of the conference to an additional 7 nights, those extra nights are not deductible to you. Nor is the airfare you bought for your wife to have her come meet you when the conference ended.
Just because an organization is a non-profit does not mean that your donation to them is tax deductible. There are certain civic organizations and organizations that contribute to social welfare that are not qualified.
If you aren’t sure of a charity's status, don’t be afraid to ask. Usually their website will have this information.
Tangentially related: Kickstarter, GoFundMe, IndieGoGo etc. are almost never tax deductible. That family you donated to after their home tragically burned down is an amazingly kind gesture. Unfortunately, it will not help you save on your taxes.
Generally these contributions are viewed as personal gifts - not charitable donations. Again, the vast majority of people donate because they want to, not for the tax benefit.
Those are the 8 most common things I see people think are deductible that actually aren’t.
Thank you for reading and I hope that cleared up some confusion if you had any!
See you back here, next week.
Financial Advisor