After doing taxes this year I am always glad to see that interest from my home equity loan and my wifes student loan are entered into the form at some point and i’m told are “tax deductible”.
My question is this: I’ve never done the math to figure it out, but does all the interest really get taken off whats paid to the government or in my case get added to my refund? Or is it a percentage of that?
Reading Publication 936 from the IRS might help.
As with any tax-deduction, the benefit is the tax that would have been paid on such amounts. Therefore, if you itemize (rather than take the standard deduction), and you deduct $10,000 from your income as mortgage interest, you will not pay taxes on that $10,000. Depending on your tax bracket, this can result in a large savings because the more taxable income that you have, the higher the percentage of income which is paid as tax. In the end, however, such a deduction likely reduces your tax payment (or, in your case, increases your refund) by 20 to 30 percent of the amount of the deduction (or $2,000 to $3,000).
Of course, a tax-deduction should be differentiated from a tax credit. A tax credit reduces your tax burden (or increases your refund) on a dollar for dollar basis. Most tax credits will not reduce your tax burden below zero. This means that if you owe $500 in taxes, but are entitled to a credit of $1,000, that your tax burden will be $0 rather than -$500. However, some credits do go below zero resulting in the US governemtn actually owing the taxpayer money directly. In such a case, any withholding would be returned upon filing that year’s Form 1040, along with the amounts the government owes for the credit.