WHAT DOES TAX-DEDUCTIBLE MEAN?

What Does Tax-Deductible Mean?

What does tax-deductible mean? Why does it matter? Understanding tax deductions is essential for effective financial management, especially for property owners and investors. A tax deduction allows you to subtract certain expenses from your taxable income, thereby reducing the amount of tax you owe. But: It’s important to note that a tax-deductible expense doesn’t equate to a full reimbursement of the amount spent. Why?

Tax-Deductible: A Definition

When an expense is tax-deductible, it means you can deduct its cost from your total taxable income. This deduction lowers your taxable income, which in turn reduces your tax liability. Expenses can be fully tax-deductible, partially deductible, or not deductible at all.

• Fully Tax-Deductible Expenses:  You can deduct 100% of these costs from your taxable income. For example, if you spend $4,000 on new carpets for your rental property, you can deduct the entire amount from your rental income. (See this article for some more examples of what business can deduct)
• Partially Tax-Deductible Expenses: Only a portion of these expenses can be deducted. For instance, if you use your personal phone for both business and personal purposes, you might be able to deduct 50% of the cost, reflecting the business use portion. Or going on business-related travel can be partially deductible. (Want to know how? See this article)
• Non-Deductible Expenses:  These are personal or unrelated expenses that cannot be deducted from your taxable income. For example, purchasing personal groceries with your business account would not be tax-deductible. Your personal insurance premiums are likely non-deductible

How Much Tax Will I Get Back?

The amount you save from a tax-deductible expense depends on your marginal tax rate. In New Zealand, the top marginal tax rate is 39%. Therefore, if you’re in this tax bracket, a fully deductible $1,000 expense could reduce your tax by $390. It’s a common misconception that a tax deduction equals a full refund of the expense; in reality, it reduces your taxable income, not your tax bill dollar-for-dollar.

Factors Influencing Tax Deductions

Several factors can affect how tax deductions apply to you:

• Tax Structure: Your business structure (e.g., sole trader, partnership, company, trust) influences how deductions are applied and how losses are treated.
• Income Levels: Your total income determines your tax bracket and, consequently, the percentage of tax savings from deductions.
• Specific Tax Laws: Regulations such as loss ring-fencing can impact the extent to which rental property losses affect your overall tax situation.

Maximizing Tax Deductions

To make the most of tax deductions:

1. Maintain Accurate Records: Keep detailed receipts and documentation for all expenses.
2. Differentiate Expenses: Clearly separate personal and business expenses to avoid confusion and potential issues with tax authorities.
3. Consult Professionals: Engage with tax professionals or accountants who can provide personalized advice based on current tax laws and your specific circumstances.

Understanding what “tax-deductible” means and how it applies to your financial activities can lead to significant tax savings and more efficient financial planning. Always stay informed about current tax regulations and seek professional advice to ensure compliance and optimization of your tax position.

We hope this helps! If you have further questions, please contact us.