The after-tax cost of debt is the true cost of debt once possible tax benefits are taken into consideration. There are some circumstances in which debt reduces the tax load. A well-known example is the interest on mortgage payments. When these deductions are taken into account, it actually reduces the amount of debt that a person truly owes. In order to find out exactly what the after-tax cost of debt really is, the consumer will need to do some research in order to find out what his or her tax bracket is and the amount of interest that can be deducted from the owed taxes.
First, the taxpayer will need to look at a tax table in order to find out which bracket he or she belongs to. This bracket will show which percentile of the population the taxpayer belongs to with regard to annual income. The next thing to do is calculate how much interest can be deducted from the taxes owed. Itemized deductions will tell the taxpayer how much interest can be deducted using either a mortgage or investments.
Once the taxpayer finds his or her tax bracket, he can then divide it by 100 to convert it from a percentage to a decimal. As an example, if he or she was in the 28-percent tax bracket, the person would need to divide 28 by 100 to get 0.28. The decimal amount will then need to be subtracted from 1. This number is then multiplied by the amount of interest that was deducted from the taxes; the number produced will be the after-tax cost of debt.
Using the after-tax cost of debt helps to display the true cost of debt because expenses are almost always deductible. A person who paid $10,000 US Dollars (USD) in mortgage interest and is in the 28-percent tax bracket would have an actual debt cost of $7,200 USD. It is important to use these numbers to ensure a person does not over- or underpay when filing taxes and figuring true debt costs.
Deciding what can be used for the itemized deductions and then applied to figure after-tax cost of debt can be confusing for one who doesn’t understand the applicable laws. It is generally advised that the taxpayer request all necessary documents and research material to fully explain what needs to be done. If it seems like too large of a task, many taxpayers simply use tax software or consult professionals for a fee.