Question

Hi can someone please give an example for a tax basis and a tax benefit and the difference between the two. I am getting this switched up and clearly am grasping the concept. Thanks!

Answer 1

Tax Basis:

The basis of property is generally the property's cost: the amount paid for the property in cash or other property. Holding period refers to the duration of time owned based on the purchase date.

For example, if Nani acquires a building for $10,000 cash and assumes a mortgage for $80,000 (which is his liability assumed), Nani's basis in the building is $90,000. If multiple items of property are acquired together in a single transaction, the tax basis must generally be allocated to the items in proportion to their values at the time of acquisition.

Fungible property (e.g., bushels of wheat or shares of corporation stock) may include items of property acquired at different times with differing bases. If such property is sold, the taxpayer may need to use an assumption (such as average cost or FIFO) for determining the cost of the portion of the property sold.

Tax Benefit:

A tax benefit is an allowable deduction or credit on a tax return intended to reduce a taxpayer's burden while typically supporting certain types of commercial activity. A tax benefit allows some adjustment benefiting a taxpayer's tax liability.

Tax benefits come in the form of deductions, credits, and exclusions, each of which has a different structure and a different effect on individual income tax liabilities.

A) Tax Deduction: A tax deduction reduces the taxable income of a taxpayer. If a single filer’s taxable income for the tax year is $75,000 and he falls in the 25% marginal tax bracket, his total marginal tax bill will be 25% x $75,000 = $18,750. However, if he qualifies for an $8,000 tax deduction, he will be taxed on $75,000 - $8,000 = $67,000 taxable income, not $75,000.

B) Tax Credit: A credit is a tax benefit that provides more tax savings than a tax deduction as it directly reduces a taxpayer’s bill dollar to dollar, rather than just reducing the amount of income subject to taxes. In other words, a tax credit is applied to the amount of tax owed by the taxpayer after all deductions are made from his or her taxable income. If an individual owes $3,000 to the government and is eligible for a $1,100 tax credit, he will only have to pay $1,900 after the credit is applied.

C) Tax Exclusion: Tax exclusions classify certain types of income as tax-free and reduce the amount that a tax filer reports as their total or gross income. Incomes are excluded to encourage taxpayers to engage in a particular activity. For instance, workers who get job-based (or "employer paid") health insurance coverage have a tax benefit given that they do not pay taxes on the value of those policies and employers can deduct the cost as a business expense.