Few topics around money generate more emotions than taxes. Most of us have serious money scripts when it comes to paying taxes. Let’s take a look at a few of those money scripts that can actually cost you money.
It’s common to hold money scripts that tax write-offs and deductions are good things that lower our taxes. The problem is, in the majority of cases—I don’t know exactly, but I’d guess maybe 80%—a tax write-off is an actual loss. It’s real money out of your pocket.
A common example is the home mortgage interest deduction. Over the years I’ve heard a lot of people say, “Oh, I don’t want to pay off my mortgage; I’ll lose the tax deduction.”
Let’s look at the numbers. For most of us, the mortgage interest deduction is worth 12 cents for every dollar paid in interest. This applies if you’re in a 12% tax bracket, which you probably are if your taxable income as a couple is around $70,000 to $80,000. That means you have to spend 88 cents in mortgage interest to save 12 cents in taxes. If you don’t have a mortgage, for every dollar that you now do not spend, you’ll pay 12 cents more in taxes—a net gain of 88 cents. So logically speaking, reducing your net worth by a dollar in order to save 12 cents is not a great money decision.
Another money script around taxes is rejecting income because it will put you into a higher tax bracket. I’ve seen people turn down raises or other income for this reason.
Again, some numbers. For a couple in the 12% tax bracket, the ceiling on that bracket is currently $81,050. If you’re earning $81,050, and you get just one dollar more, that puts you at $81,051 and bumps you up to the 22% tax bracket.
Should you take the extra dollar? Absolutely. Here’s why. Here’s what many people misunderstand. They think when you go into a higher tax bracket, that means all of your income is taxed at the higher level. So instead of $81,050 being taxed at 12%, you’d have $81,051 taxed at 22%. You’d have to pay around $8,000 more, which would make no sense—if that’s what would happen. It isn’t.
That’s not how it works. The higher tax bracket only applies to income over $81,050. If your income went up to $81,051, you would still pay 12% on the first $81,050 of income. You would pay 22% on only the extra dollar.
So by turning down that dollar, you would turn down 78 cents in net income. By taking the dollar, you would pay 22 cents more in taxes and still be 78 cents ahead.
If you have read these two explanations and followed the logic, your reaction might be, “Holy cow, that makes a lot of sense. I didn’t understand the numbers before.” Just gaining more information and clarifying the facts might be enough to change your perspective and your behavior around these two tax deduction money scripts.
But it isn’t always that simple. Your reaction might be, “Okay, I get that. But I still can’t just go pay off my mortgage. I just can’t see putting myself in that higher tax bracket.” Your emotions might still argue against the numbers and the logic.
What is that about? Well, I don’t know exactly what it is for you, but it’s worth exploring. One way to explore this is to sit with yourself and have a discussion with the part of yourself that’s holding onto the money script. To listen to what that part has to tell you.
Typically, money scripts like these go back to something that happened in childhood. In the case of taxes, maybe you learned from things your parents said that you never want to pay more taxes—that the government is corrupt, or they’ll waste your money, or whatever it might be. Or you’ve read or heard some financial gurus talk about not paying off a mortgage. Or maybe you’ve developed a belief that you ought to be ashamed if you don’t try to pay the lowest amount of tax possible.
Just remember, whatever is going on emotionally makes perfect sense. Once you get to what the money script is and where it came from, there is a logical and well-intentioned reason behind it. Understanding and appreciating that reason will help you let go of the money script that may actually be costing you money.
Check out The Financial Therapy Podcast by Rick Kahler concerning this topic.
