Exclusion Ratio
The ratio of the number of people inside a nightclub compared to the number of people waiting outside by the velvet ropes.
Also, a measure of what percentage of an investment return is not subject to taxation.
You put $1,000 into an investment. When you sell it, you end up with $1,100. However, $1,000 of that amount was your original investment, not a taxable gain. The government doesn't get a piece of the money...you had it already. So only the $100 profit is taxable. The exclusion ratio here is 90.9%.
However, some investments aren't as straightforward. If you contribute sums to a tax-deferred investment over a long period of time, with different dollars earning different long-term return rates, determining the exclusion ratio can get more complex.
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Finance: What is a Tax Deduction?102 Views
Finance allah shmoop shmoop What is a tax deduction Uh
taxes Love him Hate him You can't leave him but
you can lower them legally by being you know thoughtful
about how you spend your earnings All right How do
we do this Well let's start with the largest tax
deduction in america the home mortgage And you you the
dentist who makes one hundred fifty grand a year for
putting your fingers in wet mouth Well remember that for
individuals versus corporations we pay a graduated or quote progressive
unquote tax rate Like almost nothing On the first fifteen
grand we earned on about ten percent from fifteen to
thirty grand And then about twenty percent from thirty to
sixty grand And so on That's progressive So on the
last twenty grand of earnings you make well you might
pay say forty percent in taxes and yeah we know
the numbers own exact We're just illustrating a point Here
you have a mortgage of three hundred thousand dollars on
a home you bought for four hundred thousand dollars right
So you put a hundred grand down and borrow three
hundred The mortgage costs you six percent per year in
interest or eighteen thousand dollars to rent that three hundred
thousand before you owned the home The irs thought of
you as one hundred fifty grand a year earner but
one hundred percent of the interest on the home is
fully tax deductible So what about that last twenty grand
iii The money you earn from one hundred thirty k
to one hundred fifty k Well as faras the irs
is concerned now that you have a home you get
taxed as if you earned just one hundred thirty two
grand not one hundred fifty k actually earned Why Because
that eighteen thousand dollars in interest comes right off the
top of your earnings See there's the math right there
one hundred fifty minutes eighteen hundred thirty two taxable earnings
it's as if you didn't earn that money ever can't
all right well if you'd had no deductions on that
last twenty thousand dollars of earnings you'd have paid forty
percent or eight thousand dollars in taxes But now on
that last twenty thousand dollars thanks to your mortgage deduction
well you only have taxable income of two thousand dollars
And yes you pay forty percent on that two thousand
Or eight hundred bucks And you mumbled thank you government
for largely splitting the cost of my mortgage with me
The american dream is alive and well that's what you
say Okay And thank you jay There are other deductions
beyond home mortgages of course but well you get the
gist here of how they work from a taxpayer's perspective
Deductions like those from your home mortgages are a good
thing Common personal deductions also include things like prepaid healthcare
costs and the cost of feeding quote dependent unquote children
Aii those noisy things sleeping in your spare bedrooms until
they're eighteen Okay so those air personal deductions things that
individual citizens take But what if you're a corporation Well
in a way it's kind of easier Think of most
corporations is having a flat thirty percent tax from the
first dollar they make just keep things simple Participation trophy
company in kameda one hundred million dollars last year and
paid thirty million in taxes They netted seventy million after
tax The company really needs a new trophy smelting machine
because with so much demand for participation trophies of late
while the old one is running dullah with mediocrity the
company spends forty million box on the new machine knowing
that it will be worthless in ten years either because
it wears out or because the country gets riel or
you know simply remembers to you know have a nice
day participation trophy land Welcome to it They'd appreciate forty
million dollars in equal parts of four million box each
year over ten years so that in the next year
when they again or in one hundred million dollars well
they now get to deduct four million bucks and appreciation
from their smelting machine against their hundred million dollars in
earnings So again as faras the irs is concerned they
didn't really earn one hundred million dollars even though they
did They earned quote on ly unquote ninety six million
and yes they still pay their thirty percent tax Only
now instead of paying it on a hundred million bucks
it's paid on ninety six million of earnings or point
three times ninety six or twenty eight point eight million
in taxes they did Abducted from their taxes The four
million box expected value decline from their smelting machine Right
It goes down four million a year in value from
the forty they paid They received essentially a credit on
their taxes of one point two million dollars So instead
of that year's depreciation costing the company four million bucks
well it really cost them more like two point eight
million If you ignore a bunch of other things like
the original capital cost of the machine what else they
might have done with that money oven you know via
smelting machine Think think Corporate jet Yeah those g sixes 00:04:52.774 --> [endTime] are surprisingly tasteful