A tax deduction is an expense that can be subtracted from taxable income, reducing the total amount of income subject to taxation.
By lowering taxable income, tax deductions can help individuals and businesses reduce the amount of tax they owe.
Unlike a tax credit, which directly reduces the tax bill, a tax deduction works by decreasing the income on which tax is calculated.
Tax deductions come in many forms, often depending on government policies and tax laws. Common deductions include expenses related to work, education, medical costs, and charitable donations.
For businesses, tax deductions may cover operating expenses, depreciation, and employee salaries. The availability of specific deductions varies based on tax regulations and an individual's or company's financial situation.
Some tax deductions apply automatically, while others require documentation and eligibility checks.
Many tax systems allow for standard deductions, which provide a fixed reduction in taxable income, or itemised deductions, where individuals list specific expenses that qualify for deductions. Choosing between these options depends on which provides the greater tax benefit.
The impact of a tax deduction depends on the tax rate of the individual or business. A higher taxable income means a deduction has a greater financial benefit. For example, if a person falls into a higher tax bracket, a tax deduction will reduce their taxable income at a higher percentage, resulting in more savings compared to someone in a lower tax bracket.
Understanding which expenses qualify as tax deductions is important for effective tax planning, which makes it important to keep accurate records of your deductible expenses to ensure you do not miss out!