A tax deduction
or a tax-deductible expense
affects a taxpayer's income tax
. A tax deduction represents an expense incurred by a taxpayer. It is subtracted from gross income
when the taxpayer computes his or her income taxes. As a result, the tax deduction will lower overall taxable income
and the amount of tax paid. The exact amount of tax savings is dependent on the tax rate
and can be complicated to determine.
A tax credit is a similar concept, but is different in that it reduces the tax paid dollar-for-dollar. This amount of tax savings is not dependent on the rate the taxpayer pays.
The United States
' tax system has many different types of deductions. At a high level there are "above the line"
and "below the line" deductions. "The line" that these two terms refer to is a literal line on US tax forms. After calculating Total Income, the taxpayer subtracts above the line deductions to determine Adjusted Gross Income
. After this, there is a solid line (and the end of the page). Below the line, each taxpayer chooses between a standard deduction
or itemized deductions
, 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 income
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 , , and -.
- An exemption amount for the taxpayer, the spouse, each child, and any other qualified dependents, and certain disabilities;
- Mortgage interest paid on one's primary residence 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 or Line of Credit interest;
- Certain taxes paid;
- Charitable contributions to eligible entities;
- Business deductions, such as mileage, 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), not to exceed business income;
- Hobby expenses but only up to the gain attributable to that hobby.
- Removal of architectural barriers to the disabled and elderly;
- Union and professional dues;
- Medical expenses above a certain percentage of the individual's Adjusted Gross Income (AGI);
- The cost of tax advice, software, and books;
- Depreciation 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;
- Educational expense (but only if it does not prepare one for a new career);
- The oil-depletion allowance or similar for depletion of timber and other natural resources, and reforestation expenses;
- State and local taxes (i.e., income tax or property tax or use taxes);) 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.
- Capital losses (to a limit), such as from the sale of stock that has lost value, that exceed an individual taxpayer's capital gains 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 rent in lieu of mortgage.
Tax deductions start to "phase out" for married individuals, filing jointly, with an income of about $145,000 or higher (2005); beyond that point, the full amount of the expenses cannot be deducted.
While broadly similar, tax deductibility in Australia differs from the United States in a number of key areas:
- There are no State and Local income taxes, although the States administer a Pay-roll Tax regime
- Personal and Corporate taxation regimes are significantly different
- There is a tax free threshold (income up to this level is not taxed)
- Income tax is charged at a higher rate for those on very large incomes
- There is a small allowance (tax offset) for a dependent spouse - children may be covered by social security type payments known as Family Tax Benefits
- Loan interest payments on a primary residence (where one actually lives) is not deductible
- Loan interest payments and other expenses on investment properties are generally deductible
- Business lunches (and similar meal entertainment-type expenses) are only deductible when Fringe Benefits Tax is incurred
- Travel to/from work is generally not deductible, although there are some exceptions
- Job search expenses are not deductible
- In general terms, expenses incurred directly in pursuit of future profits from personal investment/business activity are tax deductible. This includes interest payments on a loan to buy shares, for example.
In the UK
, Her Majesty's Revenue and Customs
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)
- 26 US Code §§ 161 to 198 (Part VI Itemized Deductions)