The Land of Wonky Tax Deductions

It’s tax season everyone! This is the time of year where people complain about taxes if they owe any money, or rave about their huge refunds. If they owe, they blast the government and those who run it, and if they get a refund they brag to their friends about their new vacation plans to coworkers since they showed Uncle Sam who is boss! When in reality they were just bad tax planners for the previous year. (Just as a heads up, this post is meant to be tongue-in-cheek and not political by any means)

I read A LOT of articles, blogs, and books about personal finance, financial independence, business, etc. I always love when someone from the FIRE community gets featured in a big financial news outlets, and all the comments that come with it. Sometimes when the general public catches wind of tax loss harvesting, Roth conversion ladders, or ACA subsidies they flip out and claim that people are taking advantage of or gaming “the system” and have some harsh things to say.

By no means am I trying to pick sides or say anyone is in the right or wrong, but this whole issue brought an idea to my head. As most of you know I am an accountant by trade and have done my own personal taxes since I was 15. Through my personal finance and tax reading (I’m an exciting guy) I have run into some pretty wild tax deductions out there. Many of them are allowed for people with six figure incomes as well. So what am I going to do about these wonky tax deductions? Make fun of them of course!

I believe many of these deductions have been around so long that people are so used to taking them, they don’t take a step back and think about how amusing some of them are and ask who they are benefiting. Let’s take a look at some of my favorites below! As a heads up, with regards to a majority of the deductions mentioned below, there are income limit phase outs which limit the use of these deductions as your income goes up, so not everyone can take advantage.

  1. Mortgage interest deduction – This is the probably the most common deduction people are aware of. You are able to reduce your taxable income by the amount of mortgage interest you pay. Some may think that there would be some kind of limit on the amount of interest you can deduct, because certainly you wouldn’t think a person owning a McMansion would be able to deduct all of their mortgage interest. Well you are somewhat correct. You are able to deduct all your mortgage interest on up to ONE MILLION dollars worth of debt. It doesn’t stop there, it’s not only for your primary residence, but also your secondary residence. So you’re able to deduct all the interest related to your $600k primary home mortgage along with the interest related to your $400k mortgage on the lake house. This makes me a sad renter (not).
  2. HELOC interest deduction – If deducting the interest on your primary residence and your lake house isn’t cool enough, you can also reduce your taxable income by the amount of interest you paid on your Porsche that you bought with your home equity line of credit. Have a little equity in your home? Go to the bank and take out a HELOC. You’re able to use this money on anything you want, not just making improvements to your house. So obviously you should use it to buy a Porsche! You’re able to deduct the interest you paid on up to $100 thousand of home equity debt, no matter what you spent the money on.
  3. PMI – So back in 2006, you bought your dream home. The bank was nice and didn’t make you put anything down! One problem with a no-money-down mortgage is that you have to pay private mortgage insurance. Well the government feels bad that you bought a house that you can’t afford, so they let you deduct your private mortgage insurance!
  4. Moving expenses – Live on the East coast and got a new bang up job in in Silicon Valley? Your moving expenses are tax deductible!
  5. Tuition expenses – Your rich parents make too much to take this deduction but they want to pay for your college. They’re allowed to gift you $28 thousand a year, tax-free and then you’re able to deduct $4,000 a year in tuition expenses. That’s $4,000 of your internship money, tax free, plus a free education! Not too shabby!
  6. Loss carryforward – Lost your hat in investing in that solar company that some guy at the bar pitched you? Well there is some light at the end of the tunnel. You’re allowed to deduct up to $3 thousand a year from your income for investment losses. You lost $10 thousand you say? That’s okay you can carry forward the $7 thousand you couldn’t take this year, and carry it into the following years until it is all used up.

Now the next item isn’t related to most individuals but I think is the craziest tax rule out there, so I figured I’d share it with you all:

Carried interest – This by far, in my opinion, is the craziest rule with regard to personal income taxes. Without getting too into the nitty gritty, partners in a hedge funds or private equity funds get compensated based on the performance of their fund. As long as their fund performs well, they get a huge fee that you read about in the news. So when Mr. Hedgefundtitan makes $200 million dollars in a year, since he’s doing such a service to the public, he’s allowed to defer his income and pay capital gains rates on that income which caps out at 20%. If he was you or I earning that money, we’d have to pay 39.6% since we aren’t partners in a hedge fund… womp womp. That’s a savings to Mr. Hedgefundtitan of almost $40 million!

In closing, there are a ton of laws and rules out there that may benefit certain individuals, and sometimes that individual may not be you. Nothing ever is going to completely make sense in terms of who is benefiting or not benefiting, so personally I like to control what I can and brush off the things that are not in my power. Oh and of course I love to poke fun at some tax laws in the process.

Will you be getting a refund or owing this year? Do you love or hate tax season?

34 thoughts on “The Land of Wonky Tax Deductions

  1. John

    As a CPA, I’m all too familiar with the craziness of our tax code! I’d gladly give up all the deductions for a lower rate just to make things simpler. I’m not sure that will ever happen as Congress enjoys the benefits for handing out favors, but it’s nice to dream about!

    As I wind up my freelance accounting work this year and end my full-time accounting career, I can’t say that I’ll miss year end/tax season! Just one of the benefits of early retirement that I’m looking forward to!

    Thanks for your post.

    John
    John recently posted…Three Ways to Use Your CashMy Profile

    Reply
    1. Fervent Finance Post author

      As I get older, taxes get to be more of a chore. More 1099s, more phase outs, states constantly changing rules, etc. I used to enjoy them when it was just a W2 and some student loan interest. Not anymore!

      Reply
      1. Fervent Finance Post author

        I don’t want to put my fellow accountants out of business but I agree it is way too complicated.

        Reply
  2. Matt @ The Resume Gap

    Completely agreed; I don’t buy the argument that being efficient with tax loss harvesting or claiming ACA subsidies is any more “unfair” than the enormous number of tax deductions that most people claim. Many Americans, particularly those who outsource their tax return preparation, are probably completely oblivious to the various deductions from which they benefit, like the earned income tax credit or mortgage interest deduction. I’m not defending those policies (I would support a massively streamlined tax code), but you’re not “gaming the system” by optimizing around the current rules.

    Reply
    1. Fervent Finance Post author

      You’re right about outsourcing the return. Those people just see how much they owe or get as a refund and don’t understand the math that gets them to that point.

      Reply
      1. Andrew@LivingRichCheaply

        It’s a bit of a pet peeve of mine when people with easy W-2 salaries outsource the return. Then they tell me that their tax preparer did a good job because they got a bigger refund than I did. Yea, they definitely don’t understand how taxes work. I’m a bit of a geek but I somewhat enjoy learning about tax stuff so that I can optimize and pay as little taxes as possible

        Reply
  3. Norm

    You and I are on the same wavelength, Fervent. I agree, some of these are pretty gross. The mortgage interest deduction is the most persnickety. I’d like to think it’s only still around because the national realtors’ association has so much influence. But then how could you practically persuade the public that getting rid of it is a good idea? It’s a deduction that almost everyone gets, and it’s hard to make the argument that it’s benefitting the rich so much more than the poor. (I’m a good example: My wife and I hardly ever itemize deductions. Since our house was so cheap, the interest doesn’t add up to enough!) I don’t know if I’d like to see it eliminated, but there should be a dollar amount limit. I know people factor in the tax effect when considering how much to pay for a house, so the effect of getting rid of the deduction might just be that housing prices drop accordingly as people can “afford” less house.
    Norm recently posted…My Experience Using Cozy for LandlordsMy Profile

    Reply
    1. Fervent Finance Post author

      Unfortunately, since I live in Manhattan I itemize just because of state and local income tax. I guess it’s “good” in a sense since I now can at least get deductions for my charitable contributions and other items. Without getting political, I think they should at least lower the $1m cap on mortgage interest to $500k.

      Reply
  4. Mr. SSC

    Taxes are pretty crazy, and the seemingly arbitrary laws that comprise them just grow like a self-feeding demon, or some other crazy creature. 🙂
    We just found out that our dependent care savings that we could put $5k tax free in and use for daycare, had been revisited during 2015 and we didn’t fit in that category anymore. “It will now be added to an amended W2 as “income” and we will get taxed for it. Thank-you come again” So frustrating…. Especially more so to the single income friends of ours that got the same note, because now they have $5k they owe taxes on before any deductions (if we’re eligible, which we’re usually not for most) start to get applied.
    I’m just super glad Mrs. SSC likes dealing with taxes – except when she starts asking for tax stuff back in November….
    Mr. SSC recently posted…January 2016 Budget Update: It’s retooled!!My Profile

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  5. Abigail @ipickuppennies

    I think we’re going to either just barely break even or maybe owe a couple hundred. Either way, nothing mind-blowing, which is fine by me. If I get more than $300 back, I’m annoyed that we didn’t have the money throughout the year.

    You’re right that the home-based deductions are pretty insane when you actually think about it. What really blows my mind is when people say that it might not be as good a deal to pay off your house early because you lose the deduction. Yeeessss, but you ALSO lose the home payment. Guess which one is a better deal?

    Reply
    1. Fervent Finance Post author

      I cringe when I hear people make that excuse for having a mortgage. Good job coming close to breaking even on taxes.

      Reply
  6. Alyssa @ GenerationYRA

    What’s incredible to me is that one of the biggest arguments people would make to my fiance & I about “needing to buy a house” was for the benefit of the mortgage interest deduction with taxes. Yeah..we’re still renting. I can’t believe it’s up to $1 million, I did not realize that! Tax season is rough for me, because it just boggles my mind what people “plan” to do with their tax refunds (free money right??) I want to get to the point where I break even, but if I do get a refund I’m investing it straight away!
    Alyssa @ GenerationYRA recently posted…Money & EssentialismMy Profile

    Reply
    1. Fervent Finance Post author

      Hi Alyssa. Do you say to them “it’s not worth it” or do you just let it slide? It’s a tough convo to have. Great goal with your refund. I changed my W4 at the end of 2015, so looks like I’ll owe about 500 bucks. Oh well nothing earth shattering, but better than getting a big refund.

      Reply
    2. John

      I’ve always found the “I need a mortgage for a tax deduction” argument to be short sighted. Think about it: Spend $1 in interest to save $0.30 in taxes! If they want to save $0.30 in taxes, make a charitable contribution for a $1! You’ve spent the same – and “saved” the same in taxes – and a charity benefited instead of the bank.

      The only time I could agree with their argument is if they were a bit short of being able to itemize and the mortgage interest allowed them to itemize so they could also deduct contributions, real estate taxes, personal property taxes, medical, etc. But this is a VERY rare situation.

      John
      John recently posted…What were you thinking?My Profile

      Reply
  7. Financial Grind

    I WAS really excited to start my taxes this year. Until I found out there was a student loan interest deduction cap of $2500 :(. I wish there was a excess student loan interest carry forward. ha! oh well.

    Reply
    1. Fervent Finance Post author

      Sorry to hear that FG. At least you’re not phased out of the deduction yet! Thanks for stopping by.

      Reply
  8. Broke Millennial

    Last year was my first year owing, and I think my father had never been so proud. He gets really irritated about people giving an interest free loan to Uncle Sam. This year, I’m going to owe big time because freelancing income turned out to be much higher than anticipated (I have a FT job too). But — I’m most bummed that the Lifetime Learning tax credit has a pretty low income phase out (IMHO) for those of us filing single. If only the IRS would take cost of living into consideration on income phase outs! $65,000 in NYC is not equal to $65,000 in (insert almost any other city here). Ah, well!
    Broke Millennial recently posted…Are You Paying a Luxury Tax for Your College Degree?My Profile

    Reply
    1. Fervent Finance Post author

      Hi BM. I owed this year. I don’t like giving away no-interest loans either. Yeah phase-outs aren’t perfect, just like the tax code.

      Reply
  9. Our Next Life

    Thank you for this reminder that the wealthy get tons of their own tax welfare — makes me feel less bad about taking Obamacare subsidies! There was a time when we owned two high-priced properties, and I remember asking an accountant friend, “Do I HAVE to claim all the mortgage interest? Then we’ll owe like no taxes, and we have to pay something.” His answer: Yep, you have to claim it all, because it’s been reported to the IRS. So you can’t even opt out of those tax cuts for the wealthy!!

    Reply
  10. EarlyRetirementNow

    Great blog! Love all, your posts!
    Nice to hear from an expert about the quirks of the US tax system.
    To me, the untrained professional (I’m in Finance, not Accounting), the US tax system seems so unfair. Nominal rates are high, with a hard to navigate jungle of deductions. These deductions are not really handouts then, they merely soften the blow of high rates for those who can afford to have D.C. lobbyists. The only upside: once in early retirement, we can earn ~25K ordinary income and 75K in capital gains and dividends, completely tax free (federal). Hopefully, that “loophole” will still be there when we retire in 2018!

    Reply
    1. Fervent Finance Post author

      Thanks ERN! I try not to think about or complain too much, I rather spend that time and learn it so I can be smart about my financial decisions!

      Reply

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