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Deduction: Meaning & Definition

Updated: November 25, 2022

Deductions are the measure of expenses you can subtract from your gross income when filing taxes. They can reduce the amount of taxes you owe, keeping more money in your pocket. 

When thinking about deductions, most people think of charitable donations and school tuition. While these are common deductions, there are many more that might be applicable to you. Keep reading to learn more about deductions and how they affect you.

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    KEY TAKEAWAYS

    • Deductions are a way to lower the amount of taxes you owe.
    • Mandatory deductions are required by law, while optional deductions are up to the taxpayer.
    • Deductions can save you money by lowering your tax bill.
    • There are many different kinds of deductions, ranging from charity to job-related.

    What Is A Deduction?

    A deduction is an amount you can subtract from your gross income when filing taxes. They are the expenses that are not covered by your salary, like work travel, student loan interest, or health insurance premiums. Deductions reduce the amount of your income that is subject to tax.

    This is possible by letting you exclude a specific dollar amount as a reduction in taxable income. When you file your taxes, you deduct certain expenses from your gross earnings to calculate your adjusted gross income (AGI). Once calculated, you can use what’s left over to determine how much tax you owe or get back.

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    What Are The Types Of Deductions?

    Work-Related Expenses

    These are things you spend money on as part of your job. They can include tools, training materials, or other supplies required for you to do your job.

    Self-Employed Health Insurance

    If you are self-employed, you are responsible for paying both the employee and employer share of health insurance. If you did, you may be able to deduct the employee portion from your taxes.

    Home Office Expenses

    If you regularly use part of your home as an office, you might be able to deduct some of your utilities, furnishings and repairs.

    Student Loan Interest

    If you have taken out federal or private student loans to fund your education, you may be able to deduct the interest you pay each year on those loans.

    Charitable Contributions

    If you donate to a qualified charity, you may be able to deduct the amount of your donation from your taxes.

    What is Standard Tax Deduction?

    A deduction that is available to all taxpayers and will reduce your taxable income by a specific amount. Standard deductions adjusted annually for inflation and are based on filing status. The amount you can deduct varies based on your filing status. 

    The standard deduction amounts for the 2019 tax year (for the 2018 tax year) are as follows: 

    Single: $12,200 Married Filing Jointly

    $24,400 Head of Household: $18,350 If you do not itemize your deductions, your standard deduction will be the best way to reduce your taxes. 

    Note: If you are using the standard deduction, be sure to use the right filing status.

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    How To Qualify For Deductions

    Make Sure The Item Is Deductible

    Your expenses must be legitimate and come with a receipt to be deductible. You can visit the IRS website for a full list of deductible items.

    Document Your Deductions

    If you are claiming a large deduction, such as for work-related travel or education, keep thorough records. Be sure to note the dates, locations, and people you were visiting with, as well as the purpose of the trip.

    Be Aware Of The Limits

    Some deductions have a maximum amount you can deduct. For example, the amount you can deduct for work-related travel and education expenses is capped at $3,000 per year.

    How To File A Deduction

    Compare Your Options

    If you are taking a large deduction, you have the option to itemize your taxes or claim the standard deduction.

    Keep Thorough Records

    If you decide to itemize, be sure to keep all receipts related to your deductions. Take photos of receipts if you’re worried about them getting lost.

    Track Your Expenses

    If the amount you are deducting is small, you may be able to track your expenses using a spreadsheet.

    Deductions vs Credits

    Deductions reduce the amount of your income that is subject to taxes. Credits get subtracted from the total amount of taxes you owe. Deductions get based on your specific situation. i.e, student loan interest or unreimbursed job-related expenses. 

    Credits get based on a specific criteria, such as being a veteran or having children in your household. You can take both a deduction and a credit for the same expense.

    Example of Deduction

    Let’s say you are a single filer with an AGI of $50,000, and you earned $30,000 from your job. You have $20,000 in student loan interest and paid $8,000 in unreimbursed job-related travel expenses. Look at the following equation to calculate your taxes.

    $30,000 + $20,000 – $8,000 = $28,000

    Since your taxable income is $2,000 lower than your gross income, you will only owe $2,000 in taxes.

    Summary

    Deductions are money withheld from your gross income when you file taxes. While they can reduce the amount of taxes you owe, they are not always a guaranteed deduction. You must keep thorough records of your expenses and be sure that you meet the requirements of each deduction before you can claim it.

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    FAQs on Deduction

    What are mandatory deductions?

    Most countries require businesses to withhold or deduct taxes from employees’ salaries. These are called “mandatory deductions.” The amount withheld depends on the employee’s tax bracket.

    Are deductions good?

    Deductions can be good or bad, depending on the situation. Deductions lower the amount of taxes you owe, which can save you money. However, deductions can also lower your refund or increase the amount you owe.

    Does deduction increase refund?

    No, a deduction does not necessarily increase refund. Sometimes, it can lower the amount of taxes you owe, which can save you money.

    What types of deductions are optional?

    Optional deductions are those that you can choose to take or not take, depending on your individual tax situation. Some examples of optional deductions include charitable donations and medical expenses.

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