A
tax deduction or a
tax-deductible expense affects a taxpayer's
income taxAn income tax is a tax levied on the income of individuals or business . Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate tax,...
. A tax deduction represents an expense incurred by a taxpayer. They are variable amounts that you can subtract, or deduct, from your gross income.It is subtracted from
gross incomeGross income is commonly defined as the amount of a company's or a person's income before all deductions or any taxpayer’s income, except that which is specifically excluded by the Internal Revenue Code, before taking deductions or taxes into account. For a business, this amount is pre-tax net...
when the taxpayer computes his or her income taxes. As a result, the tax deduction will lower overall
taxable incomeTaxable income is the portion of income that is the subject of taxation according to the laws that determine what is income and the taxation rate for that income. Generally, taxable income refers to an individual's gross income, adjusted for various deductions allowable by statute...
and thus lower the amount of tax paid.
A
tax deduction or a
tax-deductible expense affects a taxpayer's
income taxAn income tax is a tax levied on the income of individuals or business . Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate tax,...
. A tax deduction represents an expense incurred by a taxpayer. They are variable amounts that you can subtract, or deduct, from your gross income.It is subtracted from
gross incomeGross income is commonly defined as the amount of a company's or a person's income before all deductions or any taxpayer’s income, except that which is specifically excluded by the Internal Revenue Code, before taking deductions or taxes into account. For a business, this amount is pre-tax net...
when the taxpayer computes his or her income taxes. As a result, the tax deduction will lower overall
taxable incomeTaxable income is the portion of income that is the subject of taxation according to the laws that determine what is income and the taxation rate for that income. Generally, taxable income refers to an individual's gross income, adjusted for various deductions allowable by statute...
and thus lower the amount of tax paid. The exact amount of tax savings is dependent on the tax rate and can be complicated to determine. For some higher-income taxpayers, claiming all eligible tax deductions would result in having to pay the
alternative minimum taxAlternative Minimum Tax is part of the Federal income tax system of the United States. There is an AMT for those who owe personal income tax, and another for corporations owing corporate income tax...
, and would result in a higher amount of tax paid.
A
tax creditThe term tax credit describes two different concepts:* A recognition of partial payment already made towards taxes due.* A state benefit paid to workers through the tax system, which has the effect of increasing net income....
is a similar concept, but is different in that it reduces the tax owed, rather than reducing taxable income. This amount of tax savings is not dependent on the rate the taxpayer pays.
United States
The
United StatesThe United States of America is a federal constitutional republic comprising fifty states and a federal district...
' tax system has many different types of deductions. At a high level there are
"above the line"In the United States, an above the line deduction is a term used to describe those deductions which the Internal Revenue Service allows a taxpayer to subtract from his or her gross income. These deductions are set forth in Internal Revenue Code Section 62. A taxpayer's gross income minus his or...
and "below the line" deductions. "The line" to which these two terms refer is a literal line on US tax forms. After calculating Total Income, the taxpayer subtracts above the line deductions to determine
Adjusted Gross IncomeAdjusted gross income is a United States tax term for an amount used in the calculation of an individual's income tax liability. AGI is calculated by taking an individual's gross income and subtracting the income tax code's enumerated deductions, and is an important benchmark determining certain...
. After this, there is a solid line (and the end of the page). Below the line, each taxpayer chooses between a
standard deductionThe standard deduction, as defined under United States tax law, is a dollar amount that non-itemizers may subtract from their income and is based upon filing status. It is available to US citizens and resident aliens who are individuals, married persons, and heads of household and increases every...
or
itemized deductionItemized deduction is an eligible expense that individual taxpayers in the United States can report on their Federal income tax returns in order to decrease their taxable income....
s, whichever is larger. This is subtracted from the adjusted gross income (after being subjected to a possible phase out), to determine the taxpayer's
taxable incomeTaxable income is the portion of income that is the subject of taxation according to the laws that determine what is income and the taxation rate for that income. Generally, taxable income refers to an individual's gross income, adjusted for various deductions allowable by statute...
.
Below are some examples of tax deductions. Each deduction has its own particular requirements and may depend on the taxpayer's filing status, income, and other factors. They may have separately calculated income limits where they are available or become unavailable. They may have particular rules involving prior year tax returns. The list below is not exhaustive. Most deductions can be found in 26 U.S.C. §§ 100-250.
- An exemption amount for the taxpayer, the spouse, each child, and any other qualified dependents, and certain disabilities
Disability is defined by the Americans with Disabilities Act of 1990 as "a physical or mental impairment that substantially limits one or more major life activities."...
;
- Mortgage
A mortgage loan is a loan secured by real property through the use of a document which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
interest paid on one's primary residenceA person's primary residence is the dwelling where they usually live, typically a house or an apartment. A person can only have one primary residence at any given time, though they may share the residence with other people...
or other residence;
- Qualified mortgage insurance premiums that are treated as qualified residence interest expense, for certain home loans, for mortgage insurance contracts issued on or after January 1, 2007
- Equity loan
An equity loan is a mortgage placed on real estate in exchange for cash to the borrower. For example, if a person owns a home worth $100,000, but does not currently have a lien on it, they may take an equity loan at 80% loan to value or $80,000 in cash in exchange for a lien on title placed by...
or Line of Credit interest;
- Certain taxes paid;
- Charitable contribution
Charitable contribution deductions for United States Federal Income Tax purposes are defined in section 170 of the Internal Revenue Code as contributions to or for the use of certain nonprofit enterprises. See...
s to eligible entities;
- Business deductions, such as mileage
The Business Mileage Reimbursement Rate is an optional standard mileage rate used in the United States for purposes of computing the allowable business deduction, for Federal income tax purposes under the Internal Revenue Code, at , for the business use of a vehicle...
, related to an individual's expenses regarding their employment;
- Business startup and operation, and farming expenses (including travel, meals, and the so-called three-martini lunch
The three-martini lunch is a term used in the United States to describe a leisurely, indulgent lunch enjoyed by businessmen or executives. It refers to a common belief that many businessmen have enough leisure time and wherewithal to consume more than one martini during the work day...
), not to exceed business income;
- Hobby expenses
Section 183 of the United States Internal Revenue Code , sometimes referred to as the "hobby loss rule", limits the losses that can be deducted from income which are attributable to hobbies and other not-for-profit activities. Generally, losses which occur in for-profit activities are not limited...
but only up to the gain attributable to that hobby.
- Removal of architectural barriers to the disabled
Disability is defined by the Americans with Disabilities Act of 1990 as "a physical or mental impairment that substantially limits one or more major life activities."...
and elderly;
- Union
Union dues are a regular payment of money made by members of unions. Dues are the cost of membership; they are used to fund the various activities which the union engages in. Nearly all unions require their members to pay dues...
and professional dues;
- Medical expenses above a certain percentage of the individual's Adjusted Gross Income
Adjusted gross income is a United States tax term for an amount used in the calculation of an individual's income tax liability. AGI is calculated by taking an individual's gross income and subtracting the income tax code's enumerated deductions, and is an important benchmark determining certain...
(AGI);
- The cost of tax advice
Accountancy or accounting is the art of communicating financial information about a business entity to users such as shareholders and managers...
, software, and books;
- Depreciation
Depreciation is a term used in accounting, economics and finance to spread the cost of an asset over the span of several years.In simple words we can say that depreciation is the reduction in the value of an asset due to usage, passage of time, wear and tear, technological outdating or...
of business assets;
- Work uniforms and clothing, including such items as safety goggles or steel-toed shoes;
- Moving expenses, in some cases;
- Job search expenses as one searches for work in the same industry;
- Casualty (fire, theft) losses not covered by casualty insurance
Casualty insurance is a problematically defined term loosely used to describe an area of insurance not particularly or directly concerned with life insurance, health insurance, or property insurance. It is sometimes equated to liability insurance, and is mainly used to describe the liability...
;
- Education
Education in its broadest sense is any act or experience that has a formative effect on the mind, character or physical ability of an individual...
al expense (but only if it does not prepare one for a new career);
- The oil-depletion allowance or similar for depletion
Resource depletion is an economic term referring to the exhaustion of raw materials within a region. Resources are commonly divided between renewable resources and non-renewable resources...
of timberTimber may refer to:*Lumber, i.e. wood materials* Timber, Oregon, an unincorporated community in the U.S. state of Oregon* Timber , a 1984 arcade game by Bally Midway* An alternative spelling for Timbre...
and other natural resourceNatural resources occur naturally within environments that exist relatively undisturbed by mankind, in a natural form. A natural resource is often characterized by amounts of biodiversity existent in various ecosystems.Natural resources are derived from the environment...
s, and reforestationReforestation is the restocking of existing forests and woodlands which have been depleted.Leaves from trees emit oxygen as well as absorb carbon dioxide and other pollutants from our atmosphere. The demand of reforestation is increasing both for quality of human life reasons, biosphere support...
expenses;
- State and local tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law.Taxes are also imposed by many subnational entities...
es (i.e., income taxAn income tax is a tax levied on the income of individuals or business . Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate tax,...
or property taxProperty tax, or millage tax, is an ad valorem tax that an owner is required to pay on the value of the property being taxed. Property tax can be defined as "generally, tax imposed by municipalities upon owners of property within their jurisdiction based on the value of such property."There are...
or use taxA use tax is a type of excise tax levied in the United States. It is assessed upon otherwise "tax free" tangible personal property purchased by a resident of the assessing state for use, storage or consumption of goods in that state , regardless of where the purchase took place...
es);) in 2004 and 2005, one could choose between deducting State Sales Tax or alternatively deducting State Income Tax. This deduction was extended for two additional years in December 2006. http://seattlepi.nwsource.com/local/295345_taxes09.html
- Capital losses (to a limit), such as from the sale of stock that has lost value, that exceed an individual taxpayer's capital gain
A capital gain is a profit that results from investments into a capital asset, such as stocks, bonds or real estate, which exceeds the purchase price. It is the difference between a higher selling price and a lower purchase price, resulting in a financial gain for the investor...
s in that year;
- Gambling losses (but not in excess of gambling winnings).
Many tax deductions allowed by federal law are also allowed under the tax laws of various states. Each state government may allow additional types of expenditures to be tax-deductible, such as
rentRenting is an agreement where a payment is made for the temporary use of a good, service or property owned by another person or company. The owner of the good, service or property may be referred to as the lessor and the party paying to use the property as the lessee or renter...
in lieu of mortgage.
Tax deductions start to "phase out" for married individuals, filing jointly, with an adjusted gross income of $159,950 or higher for the 2008 tax year; beyond that point, the full amount of the expenses cannot be deducted.
Items which behave as deductions
In addition there are various activities which have the same economic effect as income but which escape inclusion into the tax base. These include the imputed rent on owner occupied residential housing and household services provided by the non-working spouse when one man works and his spouse stays at home as a
housewifeHousewife is a term used to describe a married female who is not employed outside of the home.-Multicultural norms:In agriculture studies, the word "housewife" is occasionally used referring to the person who does the majority of the chores within a farm's compound, as opposed to field and...
. But because these items are not part of the tax base, they are not technically deductions.
United Kingdom
In the
UKThe United Kingdom of Great Britain and Northern Ireland is a sovereign state located off the northwestern coast of continental Europe. It is an island country, spanning an archipelago including Great Britain, the northeastern part of Ireland, and many small islands...
,
Her Majesty's Revenue and CustomsHer Majesty's Revenue and Customs is a non-ministerial department of the British Government primarily responsible for the collection of taxes and the payment of some forms of state support....
allow certain expenses to be deductible as necessary to complete the work from which the income was derived.
Examples of allowable expenses include:
- Professional Subscriptions
- Mileage or other expenses incurred as part of the work
- A proportion of home expenses where part of the home is used for work purposes (e.g. a self-employed person who works on a computer in the spare bedroom)
See also
- Tax credit
The term tax credit describes two different concepts:* A recognition of partial payment already made towards taxes due.* A state benefit paid to workers through the tax system, which has the effect of increasing net income....
- Taxable income
Taxable income is the portion of income that is the subject of taxation according to the laws that determine what is income and the taxation rate for that income. Generally, taxable income refers to an individual's gross income, adjusted for various deductions allowable by statute...
- Tax policy
Tax policy is the government's approach to taxation, both from the practical and normative side of the question.-Philosophy:Policymakers debate the nature of the tax structure they plan to implement and how they might affect individuals and businesses .The reason for such focus is economic...
- Tax reform
Tax reform is the process of changing the way taxes are collected or managed by the government.Tax reformers have different goals. Some seek to reduce the level of taxation of all people by the government. Some seek to make the tax system more/less progressive in its effect. Some may be trying to...
- Home mortgage interest deduction
A home mortgage interest deduction allows taxpayers who own their homes to reduce their taxable income by the interest paid on the loan which is secured by their principal residence...
- Hidden Welfare State
The Hidden Welfare State is a term coined by Christopher Howard, professor of government at the College of William and Mary, to refer to tax expenditures with social welfare objectives that are often not included in discussions about the U.S. welfare state...
- Job-seeking expense tax deductions
Generally, expenses related to the carrying-on of a business or trade are deductible from a U.S. taxpayer's adjusted gross income. For many taxpayers, this means that expenses related to seeking new employment, including some relevant expenses incurred for the taxpayer's education, can be...
External links