One of the increasingly growing problems of adulthood is debt. Whether as an individual or a corporate entity, paying off debt is a necessary task that many don’t like thinking of. When left untouched, debt creeps up on you and starts multiplying behind your back.
While many do not wish to think about it, there is much to know about debt that would change how you compute it. There are actually two kinds of debt: non-tax-deductible and tax deductible. Knowing the differences between the two will affect how you handle your finances, helping you manage your money better.
Non-Tax Deductible Debt v.s. Tax Deductible Debt
Non-tax deductible debt is money borrowed for a purpose that does not deliver a return. This “bad debt” are debts paid with your after-tax earnings, lowering the total amount of income you bring back to your household. These would include your home loan, car loan, and your credit card payments.
Tax deductible debt, on the other hand, is gained when the loaned money is instead used for an income-generating expense. A tax deduction can be claimed for this debt, minimizing the total costs by a small margin. These kinds of debt include loans for investment shares or properties. In layman’s terms, you get a tax deduction for “good” use of your money when investing in an asset that generates an assessable income.
What this means for you
For tax deductible debt, the interest is considered an “expense.” Since expenses are allowed to be tax-deducted, it can be set against your taxable income—therefore lowering the total taxable income. Depending on how you utilize it, various tax deductions and concessions can apply, helping you improve your cash flow. This is where the help of a well-versed tax accountant, to maximize your tax deductions while figuring out ways to pay off your non-tax deductible debt.
Knowing this information, it is best to practice always paying your non-tax deductible debt first. This is for the reason that “bad debt” is paid with your after-tax income, meaning that the after-tax cost is higher. The total costs for paying tax-deductible debt, on the other hand, will be marginally lower, meaning the interest would not be as high.
To protect the tax-deductibility of your debt, keep your personal loans and income-generating loans separate. The trouble with investment properties is that it’s easy to mismanage, thereby affecting the interest’s status as being tax-deductible. Keeping an experienced accountant on hand is definitely the best practice when managing debt.
A good tax accountant will tell you, however, that regardless of the situation, debt is debt. The main goal is to avoid incurring debts, especially if your money returns aren’t high. Regardless, however, certain situations will find you in need of a loan—in which case, take note of the nature of your loan and whether it’s tax-deductible or not.
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