Tax deduction

A tax deduction or a tax-deductible expense represents an expense incurred by a taxpayer that is subtracted from gross income and results in a lower overall taxable income.

In everyday terms, this means that tax-deductibility increases a person's purchasing power (if the person is paying taxes), by "adding money" to the purchase that would have otherwise gone to taxes.

As a simplified example, if we assume someone has a flat tax rate of 33% and is paying taxes, they can buy something for $600 that is not tax-deductible, or something for $900 that is, and have just as much money left over. This is because the $600 represents the same $900 in earnings, but after taxes have been paid on it. However, the simplification (a flat rate of 33% taxes) does not describe the U.S. tax system in most circumstances.

Instead, the United States income tax system is progressive; as taxable income rises, a higher percentage is charged on a tiered system. E.g., in 2006 for Single taxpayers, the first $7,550 of taxable income is charged 10 percent; however, if a person has more than $7,550 in taxable income, then he or she must pay a flat $755 (10 percent of the first $7,550), plus 15% of the amount over 7,550. The next progressive tier is reached at $30,650; the percentage that is charged goes up again (to 25%) for taxable incomes above $30,650.

A tax credit is generally more valuable than an equivalent tax deduction because a tax credit reduces tax dollar-for-dollar, while a deduction only removes a percentage of the tax that is owed. Because tax deductions reduce taxable income, and taxes owed are a percentage of taxable income, then tax deductions offer a fractional reduction in taxes owed. Tax credits, on the other hand, come directly out of the taxes owed, saving the taxpayer one dollar for each dollar of credit.

As an example, if a person's highest portion of taxable income is taxed at 25% (progressive scale from 10 to 35 percent), then a $1,000 charitable contribution will result in a reduced tax bill of $250 (25% of the contribution). E.g., if a taxpayer would otherwise have owed the federal government $3,250 in income taxes; the new tax bill would be $3,000. As a second example, if a person was charged an early withdrawal penalty of $1000 for breaking a banking certificate of deposit (CD) before maturity, and that person's highest taxable income was in the 35% bracket, then the deduction would reduce the overall tax bill by $350.

[top]Deductions and Credits in the United States

Deductions lower your taxable income, and credits lower your taxes.

Tax Deduction for Charity Donations

Donations of cash and property to qualified non-profits are tax deductible. To be deductible, taxpayers must keep records of their contributions, especially of any gifts over $250. For non-cash contributions, taxpayers must keep records indicating the value and condition of the property given to charity.

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Charity Donations are Tax Deductible


Home Mortgage Interest Tax Deduction

Mortgage interest is a tax-deductible expense. Mortgage interest is reported on Form 1040, Schedule A along with other itemized deductions. Taxpayers paying mortgage interest should fill out Schedule A to see if their itemized deductions exceed their standard deduction. If so, taxpayers will save more money on their taxes by itemizing.

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Home Mortgage Interest Deduction - Claiming Mortgage Interest as a Tax Deduction


Energy Tax Credits

Summary of federal tax credits available for homeowners who purchase energy-efficient equipment. More information about the Residential Energy Credits.

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Energy Tax Credits: Energy-Efficient Home Improvement Tax Credits


Other Tax Credits

Other Tax Credits - Form 1040

How to fill out Form 1040 Lines 54 and 55 to claim other tax credits.

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Other Tax Credits - Form 1040


Adoption Tax Credit

Adoption Tax Credit: How to Claim the Adoption Credit

You qualify for the adoption tax credit if you adopted a child and paid out-of-pocket expenses relating to the adoption.

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Adoption Tax Credit - How to Claim the Adoption Credit


Child Tax Credit

Child Tax Credit: How to Claim the Child Tax Credit on Form 1040

If you have children, you qualify for the Child Tax Credit. Find out how to fill out the child tax credit worksheet and if you need to file IRS Form 8901.

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Child Tax Credit: How to Claim the Child Tax Credit on Form 1040


Retirement Savings Contribution Credit

If you contribute to a retirement plan, you may qualify for the Retirement Savings Tax Credit. How to fill out IRS Form 8880.

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Retirement Savings Contribution Credit - Federal Tax Credit to Help Save for Retirement


Education Credits

Education Credits - Hope and Lifetime Learning Tax Credits

You can reduce your taxes by claiming a tax credit for education expenses. Learn about the Hope Credit, the Lifetime Learning Credit, and other information for Form 8863.

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Education Credits - Hope and Lifetime Learning Tax Credits


Credit for the Elderly or Disabled

Credit for the Elderly or Disabled - Form 1040 Line 48

If you are age 65 or older, or if you are disabled, you can reduce your taxes with the tax credit for the elderly or the disabled. How to fill out Schedule R.

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Credit for the Elderly or Disabled - Form 1040 Line 48


Child Care Tax Credit and Dependent Care Expenses

Child Care Tax Credit & Dependent Care Expenses - Form 1040 Line 48

The Child & Dependent Care Tax Credit reduces your taxes by providing a tax credit for money you spend on day care and child care services. Find out how to qualify for the Child Care Tax Credit and how to fill out Form 2441.

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Child Care Tax Credit & Dependent Care Expenses - Form 1040 Line 48


Adjustments to Income

Adjustments to Income - Preparing Your 1040 Step 5

How to calculate and claim various tax deductions known as "above-the-line" deductions or adjustments to income. These deductions directly reduce your income, and you don't need to itemize. Line-by-line instructions for Form 1040 lines 23 to 34.

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Adjustments to Income - Preparing Your 1040


Adoption Credit

Adoption Credit - Form 1040 Line 52

You qualify for the adoption tax credit if you adopted a child and paid out-of-pocket expenses relating to the adoption. How to fill out Form 8839 and Form 1040 Line 52.

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Adoption Tax Credit - How to Claim the Adoption Credit


Alimony Paid Tax Deduction

If you paid alimony or separate maintenance to your ex-spouse, report the total amount of alimony you paid during the year as a tax deduction on Form 1040.

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Alimony and Taxes: Reporting Alimony on Your Tax Return


Casualty and Theft Losses

Losses incurred because of a casualty, disaster, or theft may be tax-deductible. Casualty and theft losses are reported on Form 4684 and Form 1040 Schedule A.

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Casualty & Theft Losses


Child Care Tax Credit & Dependent Care Expenses - Form 1040 Line 47

Child Care Tax Credit & Dependent Care Expenses - Form 1040 Line 47

The Child Care Tax Credit reduces your taxes by providing a credit for money you spend on day care and child care services. Find out how to qualify for the Child Care Tax Credit and how to fill out Form 2441.

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Child Care Tax Credit & Dependent Care Expenses - Form 1040 Line 48


Child Tax Credit

Child Tax Credit - Form 1040 Line 51

If you have children, you qualify for the Child Tax Credit. Find out how to fill out Form 1040 Line 51 and the child tax credit worksheet.

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Child Tax Credit: How to Claim the Child Tax Credit on Form 1040


Classroom Expenses Deduction

If you are a teacher, and you paid for classroom supplies and other materials out of your own pocket, you can claim those expenses on Form 1040 line 23.

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Educator Expenses: Claiming a Tax Deduction for Educator Expenses


Credit for the Elderly or Disabled

Credit for the Elderly or Disabled - Form 1040 Line 48

If you are age 65 or older, or if you are disabled, you can reduce your taxes with the tax credit for the elderly or the disabled. How to fill out Schedule R and 1040 line 48.

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Credit for the Elderly or Disabled - Form 1040 Line 48


Domestic Production Activities Deduction

Domestic Production Activities Deduction - Section 199 Deduction for Domestic Production Activities

Businesses with "qualified production activities" can take a tax deduction of 3% from net income. This is a tax break pure and simple. The more complicated the business, the more complicated the math for calculating the Domestic Production Activities Deduction. In a nutshell, businesses engaged in manufacturing and other qualified production activities will need to implement cost accounting mechanisms to make sure their tax deduction is accurately calculated.

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Domestic Production Activities Deduction - Section 199 Deduction for Domestic Production Activities


Early Withdrawal Penalty Deduction

If you incurred a penalty for early withdrawal of your certificate of deposit at a bank, you can deduct that penalty as a tax deduction on Form 1040.

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Early Withdrawal Penalty Deduction


Earned Income Credit

Earned Income Credit: Qualfying for the Earned Income Tax Credit

How to qualify for and figure your earned income credit. The EITC is a tax credit that lowers your taxes and gives you a bigger refund. Find out the criteria for qualifying children, and the special Head of Household rule if you are separated from your spouse.

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Earned Income Credit: Qualfying for the Earned Income Tax Credit


Education Credits, Hope Credit and Lifetime Learning Credit

Education Credits, Hope Credit, Lifetime Learning Credit, Form 1040 Line 49

You can reduce your taxes by claiming a tax credit for education expenses. Learn about the Hope Credit, the Lifetime Learning Credit, and other information for Form 1040 line 29 and Form 8863.

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Education Credits - Hope and Lifetime Learning Tax Credits


Educator Expenses

Educator Expenses: Claiming a Tax Deduction for Educator Expenses

If you are a teacher and you paid for classroom supplies and other materials out of your own pocket, you can claim those expenses as a tax deduction.

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Educator Expenses: Claiming a Tax Deduction for Educator Expenses


Foreign Tax Credit

Foreign Tax Credit - Form 1040 Line 46

Claiming the foreign tax credit reduces your US taxes by the amount of tax you have paid to foreign governments. An excellent tax strategy for investors and people working abroad.

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Foreign Tax Credit: Claiming a US Tax Credit or Deduction for Foreign Taxes Paid


Qualified Performing Artists

Qualified Performing Artists (QPA) Deduction

Certain professions can deduct their job-related expenses directly on Form 1040 as an adjustment to income. Professions include performing artists such as musicians, dancers, and actors. Instructions for claiming the "QPA" deduction are discussed.

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Qualified Performing Artists Expenses: Claiming a Tax Deduction for Job Expenses


Moving Expenses

If you moved to start a new job, or to seek work in a new city, you may be able to deduct the cost of your moving expenses from your income.

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Moving Expenses Tax Deduction


Self-Employment Tax Deduction

If you have self-employment income, then you can take a deduction for half of your Self-Employment Tax. This deduction is taken directly on Form 1040.

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Self Employment Tax Deduction


Self-Employment Health Insurance Deduction

You can deduct the full cost of health insurance you purchase for yourself, your spouse, and/or your dependents. You must be self-employed, and you must not be eligible to participate in a group health plan.

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Self-Employment Health Insurance Tax Deduction


SEP-IRA Deduction

You can take a tax deduction for any retirement contributions you make to a SEP, SIMPLE, or Keogh retirement plan. You must be self-employed to claim this tax break.

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SEP, SIMPLE, Retirement Plan Deduction


Early Withdrawal Penalty Deduction

If you incurred a penalty for early withdrawal of your certificate of deposit at a bank, you can deduct that penalty as a tax deduction.

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Early Withdrawal Penalty Deduction


Alimony Paid Deduction

If you paid alimony or separate maintenance to your ex-spouse, report the total amount of alimony you paid during the year on Line 34 of your Form 1040.

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Alimony and Taxes: Reporting Alimony on Your Tax Return


Health Savings Account Deduction

You can take an above-the-line tax deduction for contributions to a qualified health savings account (HSA) plan if you are covered by a high-deductible health insurance plan, and you are not covered by any other health insurance plan.

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Health Savings Account Deduction: Tax Deduction for Health Savings Accounts


Tax Deduction for Health Savings Accounts

Health Savings Account Deduction: Tax Deduction for Health Savings Accounts

Contributions to a health savings account (HSA) are tax deductible. Tax deductions are limited to $2,650 for individual insurance coverage and $5,250 for family insurance coverage for tax year 2005. To be tax-deductible, HSA contributions must meet certain criteria.

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Health Savings Account Deduction: Tax Deduction for Health Savings Accounts




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