# How do tax deductions work

Simply put: tax deductions are used to lower your taxes. But they do so in a specific way. Basically, they do not lower your tax bill directly. Instead, they lower your taxable base over which taxes are levied.

To explain this in an example: Let's say your company makes €100.000 in profit. You pay 25% taxes over €100.000 so €25.000. If you have a tax deductible of €10.000, your tax rate does not go down by that amount. Instead, your taxable income in lowered by that amount. So €100.000 becomes €90.000. And your tax rate is calculated over this last amount and will drop to €22.500, a drop of €2.500. You can also calculate this by calculating the deductible x the tax rate or €10.000 x 25% = €2.500.

Deductibles mainly benefit more profitable companies because most of our tax system is progressive. That means that the more you earn, the more taxes you pay. And if you pay more taxes, you get more back from a tax deductible. To give another example. Let say that the company in our previous example still pays 25% over €100.000. However, now the tax rate is progressive and over the first €50.000 the company pays 20% and over the second €50.000 the company pays 30%. That is still €25.000 in total. But the deductible will reduce the amount paid in the higher bracket. So after the deductible, the company will pay 20% over €50.000 = €10.000 and 30% over only €40.000 = €12.000. In total €10.000 + €12.000 = €22.000 or €3.000 less than before the deductible. If the company would only have to pay over €50.000, the company would only benefit from a €2.000 deductible because the company only pays taxes in the lower bracket and thus benefits less from the deductible.