Tax Tips: Deductions vs. Offsets

Tax Tips 2012: Deductions vs offsets

They’re so much alike, yet oh so different on your tax return.

Deduction or offset? These two tax terms tend to get confused but they’re pretty simple to set apart. Let’s take a look at why they’re similar and what actually sets them apart.

What is a tax offset?

An offset, also called a rebate, reduces the amount of tax you owe; dollar for dollar. These will reduce your tax payable to as little as zero. That in mind, offsets will never reduce your tax payable to less than zero.

So, for example, if you owe $1000 in tax and you get, say, a $400 private health insurance rebate as a percentage of the money you’ve paid into a health care plan, your tax burden is reduced to only $600. 

What is a tax deduction?

A deduction, unlike an offset, is not a direct cut in tax owed. $500 in deductions, when all’s said and done, will only reduce that $1000 of tax owed by a percentage, one that may be substantially smaller than the equivalent offset relative to the total income earned.

That’s because a deduction is a gain against income you’ve received, not tax that you owe. What it does is reduce your overall taxable income. Only indirectly then does a tax deduction reduce your tax liability.

When is an expense deductible?

A deduction is often strictly related to the specific source of that income. For instance, while a nurse may deduct the cost of buying her uniform from her income she may not do so for the uniform she used working part time as, say, a journalist.

Some occupations in fact will be rather more amenable to deductions because they are, generally speaking, more cost intensive. A construction worker is more apt to be in regular need of fresh tools while it’s unlikely an accountant will need a new calculator every fortnight.

So what’s the difference?

While deductions may have less of an immediately noticeable impact than rebates (or offsets), and tend to be job specific where offsets are more apt to be means tested, they still can make quite a difference to the size of the tax refund you’re hoping to get. Combined, these two can be extremely successful in maximising your tax refund.

Let’s toss a few figures in the mix. Taking our numbers from the tax rates for 2015 and sticking to the middle income brackets for good measure, suppose someone new to the trades made $45,000 during his first financial year.

Given the existing marginal rate of 32.5%, our tradie would owe the Federal Government $6172, representing an effective tax rate of 13.7%. Now say that throughout the year, our man was diligent in keeping a keen eye on his work related expenses and that these amounted to $7,000.

That figure is less fanciful than one may assume, specially given the high price of equipment in Australia. Our tradie may have purchased a laptop too to furnish his clients with quick calculations; his Ute mileage may have been extensive as he shuffled from job to job; and so on.

In short, his taxable income, which is to say his assessable income minus his tax deductions, is now at $38,000, just a thousand dollars above the second tier threshold of $37K.

How would that translate in terms of tax owed? Well, for one, at $38,000, his effective tax rate would fall to 9.75%, a near 4% change. As for the actual tax due, that would roll down to $3897, a reduction in tax of $2275.

I think we can all agree that is not a negligible sum. That’s why you should seek to deduct, and deduct some more.

 

WATER SPORT

Updated 22 July 2016

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