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Tax Deduction

A reduction of taxable income

What is a Tax Deduction?

A tax deduction refers to an item that is subtracted from taxable income, where an individual or an organization can get expenses deducted from their income. Tax deductions are considered a form of tax relief for the individual or organization.

 

Tax Deduction

 

It is important to note that you need to file your taxes in order to be eligible for deductions. Furthermore, there may also be a certain limit on how much you can deduct each year. For example, the U.S. Internal Revenue Service (IRS) in the United States limits the maximum amount of deductions that an individual can claim in a tax year.

In order to claim deductions, you will also need to keep proof of the expenses you incurred. For example, you will need to retain receipts and other supporting documents of any medical expenses that you paid.

 

Tax Deductions for Individuals

Individuals are allowed to claim certain expenses that can lower their tax liability. The deductions available to individuals will depend on which tax jurisdiction you are located in. Below is a list of possible tax deductions that an individual can utilize:

  • Childcare expenses: Expenses such as day care services, boarding schools, and summer camps can reduce taxable income.
  • Medical expenses: You may also be eligible to use medical expenses to reduce tax liability. They can include dental, orthopedic, and other expenses.
  • Support services for individuals with a disability: If you suffer from a mental or physical disability, you are also eligible to deduct expenses that are paid towards support services.
  • Support services for seniors: If you are a senior and you are receiving support services, you are also allowed to reduce your tax liability.
  • Union and professional dues: If you are an employee who is part of a union or a professional association, the fees that you pay can be used to claim a deduction on your taxable income.

 

Tax Deductions for Business Expenses

Organizations can claim tax deductions for certain expenses that are incurred to operate and maintain the organization. Once again, depending on where you are located, there may be different tax deductions. Below is a list of business expenses that can be deducted from the organization’s taxes:

  • Supplies: Businesses can claim deductions for supplies used indirectly in order to provide goods and services for customers. For instance, supplies can be tools and machinery used by a construction worker.
  • Office expenses: Businesses can also reduce their tax liability for the cost of items used in an office. For example, they will include paper, pencils, staples, and other stationery. Note that office expenses do not consist of computers, desks, and other furniture because they are considered capital expenses.
  • Wages, salaries, and other benefits: Companies can deduct gross wages, salaries, and benefits that a company pays to their employees.
  • Rent: If a company rents space to operate the business, the amount of rent paid can be deducted from the company’s taxes.
  • Telephone and other utility fees: Expenses such as water, gas, and electricity can be used for tax deductions. The utility expenses should only be incurred by the organization to operate the business.
  • Banking and administration fees: Companies may deduct administration expenses incurred to run the business. They can include banking fees and interest incurred on loans from the bank.

 

Tax Deductions vs. Tax Credits

It is also important to consider the difference between tax deductions and tax credits. Although both tax incentives are quite similar, they are different in how they are carried out.

A tax deduction is an amount that is subtracted from your taxable income. As such, tax deductions can be used to reduce your tax liability.

On the other hand, tax credits are deductions that reduce taxes payable. Tax credits are either refundable or non-refundable. Refundable tax credits are paid back to the taxpayer by a reduction in taxes payable or via a refund. Non-refundable tax credits are only available under certain conditions and can only reduce taxes payable.

 

More Resources

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)® certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • How to Use the IRS.gov Website
  • Indirect Taxes
  • Source Documents
  • Tax Shield

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