Tax deduction

Tax Deduction

An expense, loss, or other allowable amount that reduces taxable income rather than directly reducing tax liability, providing tax savings based on the taxpayer’s marginal tax rate.

For instance, a self-employed consultant in the 32% marginal tax bracket who claims a legitimate $10,000 home office deduction would reduce taxable income by $10,000, resulting in $3,200 tax savings (32% of $10,000), unlike a tax credit which would provide $10,000 in direct tax reduction.

Deductions fall into several categories: standard deduction (fixed amount based on filing status) versus itemized deductions (specific qualifying expenses); above-the-line deductions (available regardless of whether taxpayer itemizes); and below-the-line deductions (subject to limitations based on adjusted gross income). Common business deductions include ordinary and necessary business expenses, depreciation, employee compensation, retirement plans, and health insurance, while individual deductions may include mortgage interest, state and local taxes, charitable contributions, and medical expenses. The value of a deduction increases with the taxpayer’s marginal rate, making deductions more valuable to higher-income taxpayers.