Tax deduction

From Academic Kids

A tax deduction or a tax-deductible expense, is an item which is subtracted from gross income in order to arrive at the taxable income.

Effectively, the taxpayer pays no income tax on the amount of money he spent on tax-deductible expenses. For example, if an individual earns $50,000 in a year and gives $5,000 to tax-deductible charities, he will end up paying income tax as though he had earned only $45,000 that year. In this way governments encourage certain types of spending such as charitable contributions, home ownership, entrepreneurship, environmental protection, and education.

Some argue that the existence of the many deductions have severely bloated the tax code and that many deductions are abused and are used in situations that violate the spirit and intended purpose of these deductions. Since powerful corporations and wealthy individuals have access to lawmakers, deductions that favour these groups are common. This is a form of regulator capture. Many of these opponents favour reducing or eliminating many existing tax deductions and having the government encourage or subsidize spending on things like charities, home ownership, and education through means other than tax deductions.

United States

In the United States there are many types of deductions. The number and complexity of the amendments has often led to a call for tax reform, to simplify the tax code, at the very least.

Common examples of tax deductions for individuals follow. Each of these deductions may or may not be appropriate, given a taxpayer's filing status, income, and so forth.

  • an exemption amount for the taxpayer, their spouse, each child, and any other qualified dependents;
  • Mortgage interest paid on one's primary residence;
  • Equity Loan or Line of Credit interest;
  • Charitable contributions;
  • Business expenses (including travel, meals, and the so-called three-martini lunch; (meals and entertainment are generally only 50% deductible));
  • Union and professional dues;
  • Medical expenses above a certain percentage of the individual's total income;
  • The cost of tax advice, software, and books;
  • Depreciation;
  • Work uniforms and clothing, including such items as safety goggles or steel-toed shoes;
  • Moving expenses, in some cases;
  • Job search expenses as one searches for work in the same industry;
  • Casualty (fire, theft) losses;
  • Educational expense (but only if it does not prepare one for a new career);
  • The oil-depletion allowance;
  • State and local taxes;
  • Capital losses, such as from the sale of stock that has lost value, that exceed an individual taxpayer's capital gains in that year, up to $3,000;
  • Gambling losses (but not in excess of gambling winnings).

All tax deductions allowed by the federal government are also allowed by all the state governments. Each state government may allow additional types of expenditures to be tax-deductible.

Tax deductions start to "phase out" for individuals with an income of about $130,000 or higher; beyond that point, the full amount of the expenses cannot be deducted.

Corporations enjoy a wider range of possible tax deductions, as they are taxed on their income, and in order to calculate a corporation's income, the corporation simply subtracts its expenses from its revenues. Hence, all expenses of the business -- if the expenses can be demonstrated to have been made for business purposes -- are tax deductible.

Comedian Al Franken once did a skit on Saturday Night Live in which he purported to demonstrate the creative use of tax deductions. Among other things, Franken held up a picture of himself on vacation in Hawaii. Since he used the photo in the comedy routine in his professional capacity as a comedian, the entire cost of his trip was (allegedly) deductible. Whether Franken actually took such a deduction, or whether he got away with it, is unknown.

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