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An HR Glossary for HR Terms

Glossary of Human Resources Management and Employee Benefit Terms

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Deduction

What Is a Deduction on an Income Tax Form?

On an income tax return, a deduction is an expense a person or company can subtract from their gross income. A tax deduction decreases taxable income, which reduces the amount of tax owed to the federal government. A deduction should not be confused with a tax credit. Deductions lower the amount of income subject to tax, whereas a credit reduces the amount of tax owed.

U.S. taxpayers have the choice of claiming the standard deduction or itemizing deductions when they file their taxes. The standard deduction is a flat amount, which depends on the taxpayer’s filing status. In contrast, itemizing deductions requires that you add up all of your deductible expenses (with evidence of those expenses). You cannot itemize deductions and claim the standard deduction in the same year.

Is a Deduction Good?

Deductions are good for your tax bill, because they reduce the amount of income that is taxable. For example, if a person has 50,000 dollars in income and they deduct a 1,000 dollar donation to charity, now only 49,000 dollars will be taxed. 

When choosing whether to claim the standard deduction (which is simpler) or itemize deductions (a more complex process), it boils down to which is more, and will therefore give the greatest tax advantage. If the standard deduction is less than the sum of your itemized deductions, itemizing will save money. However, if your standard deduction is more than the sum of your itemized deductions, then go with the standard deduction.

There is no standard deduction for businesses. They must report all their gross income and then deduct every business expense. The difference becomes the organization’s net taxable income.

What Is Considered Tax Deductible?

There is no quick and easy rule to determine what expenses are considered tax deductible. The list can change from year to year, and some deductions phase out depending on the taxpayer’s income bracket. Tax preparers and tax preparation software can walk you through deductions that may apply to your specific situation.

What Is an Example of a Deduction?

There are many ways to use deductions to reduce your taxable income. Certain expenses you incur during the year can be tax-deductible. Some common personal deductions include:

  • Home mortgage interest

  • Property, state, and local income taxes

  • Investment interest expense

  • Medical expenses

  • Charitable contributions

  • Saving for college

  • IRA contributions

  • Childcare

  • Work-related education expenses

Businesses also have expenses they can use as deductions. The following business expenses are often deductible:

  • Salaries and wages

  • Asset depreciation

  • Professional services

  • Freelance/independent contract labor

  • Work opportunity tax credit

  • Office supplies and expenses

  • Client and employee entertainment

  • Employee benefits

  • Furniture and equipment

  • Computer software

  • Business location rent 

  • Utilities

  • Business travel expenses

  • Taxes

  • Commissions

  • Loan interest

  • Equipment/Machinery rental

  • Employee education and child care expenses

  • Bank charges

  • Insurance

  • Disaster and theft losses

  • Tools 

  • Education

  • Advertising and marketing

What Are Payroll Deductions?

The term deductions can also refer to money an employer takes from an employee paycheck. Do not confuse deduction with withholding, which is federal or state taxes taken from employee pay. Deductions are amounts an employer removes from employee pay for other purposes, like retirement benefits, health care costs, or special funds and donations. 

How Are Deductions Calculated?

Income tax deductions are calculated based on current tax regulations. All payroll deductions are based on gross pay, not pay after withholdings have been taken out.

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