ShmoopTube

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Finance allah shmoop shmoop What is a tax deduction Uh

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taxes Love him Hate him You can't leave him but

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you can lower them legally by being you know thoughtful

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about how you spend your earnings All right How do

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we do this Well let's start with the largest tax

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deduction in america the home mortgage And you you the

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dentist who makes one hundred fifty grand a year for

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putting your fingers in wet mouth Well remember that for

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individuals versus corporations we pay a graduated or quote progressive

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unquote tax rate Like almost nothing On the first fifteen

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grand we earned on about ten percent from fifteen to

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thirty grand And then about twenty percent from thirty to

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sixty grand And so on That's progressive So on the

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last twenty grand of earnings you make well you might

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pay say forty percent in taxes and yeah we know

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the numbers own exact We're just illustrating a point Here

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you have a mortgage of three hundred thousand dollars on

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a home you bought for four hundred thousand dollars right

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So you put a hundred grand down and borrow three

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hundred The mortgage costs you six percent per year in

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interest or eighteen thousand dollars to rent that three hundred

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thousand before you owned the home The irs thought of

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you as one hundred fifty grand a year earner but

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one hundred percent of the interest on the home is

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fully tax deductible So what about that last twenty grand

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iii The money you earn from one hundred thirty k

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to one hundred fifty k Well as faras the irs

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is concerned now that you have a home you get

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taxed as if you earned just one hundred thirty two

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grand not one hundred fifty k actually earned Why Because

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that eighteen thousand dollars in interest comes right off the

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top of your earnings See there's the math right there

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one hundred fifty minutes eighteen hundred thirty two taxable earnings

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it's as if you didn't earn that money ever can't

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all right well if you'd had no deductions on that

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last twenty thousand dollars of earnings you'd have paid forty

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percent or eight thousand dollars in taxes But now on

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that last twenty thousand dollars thanks to your mortgage deduction

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well you only have taxable income of two thousand dollars

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And yes you pay forty percent on that two thousand

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Or eight hundred bucks And you mumbled thank you government

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for largely splitting the cost of my mortgage with me

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The american dream is alive and well that's what you

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say Okay And thank you jay There are other deductions

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beyond home mortgages of course but well you get the

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gist here of how they work from a taxpayer's perspective

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Deductions like those from your home mortgages are a good

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thing Common personal deductions also include things like prepaid healthcare

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costs and the cost of feeding quote dependent unquote children

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Aii those noisy things sleeping in your spare bedrooms until

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they're eighteen Okay so those air personal deductions things that

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individual citizens take But what if you're a corporation Well

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in a way it's kind of easier Think of most

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corporations is having a flat thirty percent tax from the

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first dollar they make just keep things simple Participation trophy

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company in kameda one hundred million dollars last year and

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paid thirty million in taxes They netted seventy million after

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tax The company really needs a new trophy smelting machine

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because with so much demand for participation trophies of late

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while the old one is running dullah with mediocrity the

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company spends forty million box on the new machine knowing

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that it will be worthless in ten years either because

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it wears out or because the country gets riel or

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you know simply remembers to you know have a nice

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day participation trophy land Welcome to it They'd appreciate forty

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million dollars in equal parts of four million box each

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year over ten years so that in the next year

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when they again or in one hundred million dollars well

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they now get to deduct four million bucks and appreciation

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from their smelting machine against their hundred million dollars in

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earnings So again as faras the irs is concerned they

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didn't really earn one hundred million dollars even though they

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did They earned quote on ly unquote ninety six million

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and yes they still pay their thirty percent tax Only

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now instead of paying it on a hundred million bucks

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it's paid on ninety six million of earnings or point

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three times ninety six or twenty eight point eight million

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in taxes they did Abducted from their taxes The four

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million box expected value decline from their smelting machine Right

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It goes down four million a year in value from

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the forty they paid They received essentially a credit on

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their taxes of one point two million dollars So instead

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of that year's depreciation costing the company four million bucks

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well it really cost them more like two point eight

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million If you ignore a bunch of other things like

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the original capital cost of the machine what else they

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might have done with that money oven you know via

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smelting machine Think think Corporate jet Yeah those g sixes 00:04:52.774 --> [endTime] are surprisingly tasteful

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