Over the course of the next two days, we’ll discuss taxes and tax incentives in the context of efficiency projects. I’ll concede that, of the topics we discuss on this blog, the “tax discussion” is not the most thrilling one; however, it’s important that you have a good understanding of the financial implications of taxes as they can have a significant impact on your ability to demonstrate value for your prospects. Please note that the purpose of this blog is not to give you tax advice; it’s to provide topics to be thinking about so when the time comes, you’ll be prepared to have a productive discussion with your prospects and customers.
First, let’s talk about the difference between a tax deduction and a tax credit. A tax deduction is a reduction of the income subject to tax. A tax credit is a sum deducted from the total amount a taxpayer owes to the government. A deduction and a credit are two very different things.
If you qualify for a $10,000 tax deduction as a result of something you did to your property, that’s worth $10,000 times your marginal tax rate. If you qualify for a $10,000 tax credit, it would be the equivalent of a gift certificate for $10,000 of taxes paid.
This brings us to the topic of marginal vs. effective tax rates. If your prospect is a taxable entity, you’ll want to have a clear understanding of the difference between marginal and effective tax rates so that you can properly estimate what the tax benefits of your proposed project might be.
The marginal tax rate is the rate that applies to the last (or next) unit of taxable income or spending. The effective tax rate is the rate that you pay on all of your income after all of your various tax brackets are taken into consideration.
So, if you receive a $10,000 tax deduction and your highest tax bracket is 35% (and you have at least $10,000 in taxable income in that bracket), the deduction would be worth $3,500. You would not multiply the deduction by your effective tax rate – you would multiply it by your marginal tax rate, because that’s the amount of tax the deduction is going to offset at that tax bracket.
Stay tuned for more on this topic tomorrow…
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