What is a tax deduction?

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Summary

• A tax deduction lets you subtract certain costs from your taxable income, which can lower the tax you owe.

• Taxable income is the portion of your income that federal or state governments use to calculate your tax bill.

• Taxpayers can claim the standard deduction, a flat amount the Internal Revenue Service (IRS) lets everyone claim, or taxpayers can itemize, which means listing specific deductible expenses and using that total instead.

• Some deductions are called ‘adjustments to income’ and lower adjusted gross income (AGI), which is the income the IRS uses to calculate your taxes. A lower AGI can also help taxpayers qualify for certain tax credits or deductions.

• A tax credit works differently than a deduction because it reduces a tax bill dollar for dollar, and some credits can lead to a refund even if one owes no tax.

• If you run a business or work for yourself, many everyday business expenses can be tax-deductible. 

Understanding tax deductions can help you keep more of your money when it’s time to file your taxes. Deductions lower the amount of income the IRS can tax, which can reduce your overall tax bill and sometimes help you qualify for other credits. For employees, homeowners, and self-employed filers alike, understanding deductions versus credits can lead to more informed tax return decisions.

What a tax deduction is and why it matters

According to the IRS, a tax deduction is an amount you can subtract from your taxable income, while your taxable income is the portion of your income the government taxes. When you take deductions, you can reduce the slice of your income the IRS you need to pay taxes on. 

The value of a deduction depends on your marginal tax rate—the rate that applies to your highest slice of taxable income. A deduction doesn’t reduce your tax bill dollar for dollar. Instead, it reduces the amount of income that’s subject to tax.

Here’s a simplified way to think about it: when you claim a deduction, you’re lowering the portion of your income that gets taxed. The higher your marginal tax rate, the more valuable that deduction can be.

Deductions vs. credits

A tax credit is a benefit that reduces your tax bill directly. Unlike deductions, which lower the income that gets taxed, credits subtract from the amount of tax you owe.

Some common tax credits include (but are not limited to):

• Child tax credit

• Child and dependent care credit

• American opportunity credit

•  Saver’s tax credit

Some credits, like the Earned Income Tax Credit (EITC), are based on how much earned income you have and your household situation. Eligibility depends on factors such as income level and filing status, and some credits may be refundable.

Credits and deductions work in different ways. Tax credits reduce your tax bill directly. Deductions, on the other hand, lower the amount of income that’s subject to tax, which can reduce how much tax you owe depending on your tax situation and marginal tax rate.

Adjusted gross income and why it matters

Adjusted gross income (AGI) is your total income minus certain adjustments, sometimes called “above-the-line” deductions. These are specific expenses the IRS lets you subtract before figuring your AGI, such as student loan interest, retirement contributions, or educator expenses. Lowering your AGI could help you qualify for other deductions and credits that phase out at higher income levels.

Common adjustments include:

• Student loan interest you paid, up to annual limits

• Educator expenses if you’re a qualifying teacher or school worker

• Traditional Individual Retirement Arrangement contributions if you qualify. An Individual Retirement Arrangement, or IRA, is a retirement account with tax benefits.

• Health Savings Account contributions if you’re eligible. A Health Savings Account (HSA) is a way to set aside money for medical costs while saving on taxes.

• Half of your self-employment tax if you work for yourself

• Self-employed health insurance premiums if you qualify

• Alimony you paid under a divorce or separation agreement dated before 2019

These are reported on Schedule 1 with your Form 1040.These are reported on Schedule 1 of Form 1040, the main federal income tax return used by most taxpayers. Information from forms like W-2s and 1099s is included there.

Standard deduction vs. itemized deductions

Each year, you choose between the standard deduction and itemized deductions.

• Standard deductions: This is a set amount based on your filing status. Filing status describes your category on your tax return, like single, head of household, married filing jointly, or married filing separately. People age 65 or older or people who are blind qualify for an additional standard deduction. If someone else can claim you as a dependent, your standard deduction may be different from the standard amount for your filing status. Single filers have one standard deduction amount. Married couples filing jointly and a surviving spouse may have higher standard deduction amounts than single filers for the same tax year.

• Itemized deductions: These are specific expenses you list and total, such as mortgage interest, medical costs, or charitable donations. You could choose to itemize if your total deductions add up to more than the standard deduction. You can’t take both. Instead, compare each deduction type; typically, taxpayers  choose whichever lowers taxable income the most.

Common itemized deductions include

• Mortgage interest on a qualifying home loan

• Charitable gifts to qualifying charities, with proper receipts

• State and local taxes (SALT) include certain income or sales taxes and property taxes paid to state and local governments. Federal law may limit how much of these taxes you can deduct.

• Qualifying medical and dental expenses that are more than 7.5% of your adjusted gross income

• Casualty and theft losses from a federally declared disaster, if you qualify

Each of these itemized deductions has its own requirements. For example, medical expenses must be unreimbursed, charitable donations require receipts, and certain deductions are subject to limits or caps.

Many homeowners claim the mortgage interest deduction when they itemize, especially in the early years of a loan. Your lender sends Form 1098, which shows how much mortgage interest you paid and provides the information you need to claim the mortgage interest deduction.

Gifts to a qualified nonprofit that’s tax exempt usually count as charitable contributions when you itemize. A nonprofit is an organization that serves a public or charitable purpose, and tax exempt means it doesn’t owe federal income tax on certain income. Some deductions changed in recent years, so always check current rules before you file.

How to decide between the standard deduction and itemizing

When deciding between the standard deduction and itemizing, people often look at how their deductions compare. Here are a few things to consider:

• Itemized deductions can include things like mortgage interest, charitable contributions, certain state and local taxes (subject to limits), and qualifying medical expenses above the applicable threshold.

• Many taxpayers compare the total of their itemized deductions to the standard deduction amount for their filing status.

• Whichever option results in a larger deduction generally reduces more taxable income, though the outcome depends on individual circumstances.

• Because tax situations and rules can change from year to year, the better option may vary over time.

Deductions for self-employed people and small business owners

If you run a business or work for yourself, you can usually deduct ordinary and necessary business expenses. Ordinary means common for your trade. Necessary means helpful and appropriate.

Common examples include:

• Supplies, software, and equipment you use for work

• Business use of your car, tracked with mileage or actual costs

• A home office that you use regularly and only for business

• Advertising, insurance, and professional fees

Some business purchases, like equipment or vehicles, are expected to be used for more than one year.

You usually can’t deduct the full cost of certain business assets in the year you buy them. Instead, you generally recover the cost over time through depreciation, which spreads the cost of an asset over its expected useful life. In some cases, special tax rules may allow a larger portion of the cost to be deducted in the year of purchase if you qualify. Tax rules can change, and eligibility may depend on your situation.

Many owners of pass-through businesses—businesses where profits are reported on the owner’s personal tax return rather than taxed at the business level—may qualify for the Qualified Business Income deduction, depending on income level, business type (including whether it’s a specified service trade or business), and other factors. 

The Qualified Business Income deduction, or QBI deduction, can be up to 20% of qualified business income from a sole proprietorship, partnership, or S corporation. Limits apply based on income, type of business, and wages or assets. Remember, tax laws can change, so check the current IRS rules or consult a tax professional to confirm whether this deduction is still available.

You report most sole proprietor income and expenses on Schedule C with your Form 1040. You may also need Form 8995 for the QBI deduction if you qualify.

How to claim deductions correctly

• Gather records. Save receipts, bank statements, lender forms, and letters from charities.

• Choose your path. Compare the standard deduction with your itemized total.

• Use the correct tax forms. 

• Check your work. Names, dates, and dollar amounts should match your records.

• It’s generally recommended to keep tax documents for at least three years, which is the standard period the IRS typically has to review or audit a tax return.

• Use IRS tools if you’re unsure about whether you qualify for certain deductions or credits. The IRS Interactive Tax Assistant can help you check eligibility for specific deductions and credits.

• E-filing helps speed up processing and some automatically checks for common errors before your return is submitted.

• Individual federal income tax returns are typically prepared using Form 1040, which brings together income reported on forms like W-2s and 1099s. Taxpayers with earned income may want to review whether they qualify for credits such as the Earned Income Tax Credit (EITC), since eligibility depends on income level and filing details.

• Read our tax preparation checklist before you submit your return for educational tips when preparing to file.

State taxes

Your state may offer its own deductions and credits. Rules and amounts can be different from federal rules. Check your state’s tax agency website so you don’t miss a benefit.

Common mistakes to avoid

• Double counting by accident can happen. If you take the standard deduction, it’s important to not also itemize the same expenses. 

• Good recordkeeping matters. Receipts and statements help you verify your deductions if the IRS ever asks for documentation.

• Don’t forget caps and thresholds. The SALT deduction has a dollar cap, and medical costs must exceed a percentage of adjusted gross income.

• For tax purposes, business expenses are generally deductible, while personal expenses are not, which is why they are treated separately.

Tax deductions might seem confusing at first, but once you learn how they work, they may help lower your tax bill.

Whether you use the standard deduction or itemize, keeping good records and understanding how deductions and credits work can help when preparing a tax return. IRS tools and other reliable resources can offer guidance, and a qualified tax professional can help with more complex situations.