Tax deduction

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A tax deduction or a tax-deductible expense represents an expense incurred by a taxpayer that is subtracted from gross income and results in a lower overall taxable income.

The United States income tax system is progressive; as taxable income rises, a higher percentage is charged on a tiered system. E.g., in 2006 for Single taxpayers, the first $7,550 of taxable income is charged 10 percent; however, if a person has more than $7,550 in taxable income, then he or she must pay a flat $755 (10 percent of the first $7,550), plus 15% of the amount over 7,550. The next progressive tier is reached at $30,650; the percentage that is charged goes up again (to 25%) for taxable incomes above $30,650.[1]

Because tax deductions reduce taxable income, and taxes owed are a percentage of taxable income, then tax deductions offer a fractional reduction in taxes owed. I.e., tax deductions do not reduce taxes owed on a dollar for dollar basis. Tax credits, however, do.

As an example, if a person's highest portion of taxable income is taxed at 25% (progressive scale from 10 to 35 percent), then a $1,000 charitable contribution will result in a reduced tax bill of $250 (25% of the contribution). E.g., if a taxpayer would otherwise have owed the federal government $3,250 in income taxes; the new tax bill would be $3,000. As a second example, if a person was charged an early withdrawal penalty of $1000 for breaking a banking certificate of deposit (CD) before maturity, and that person's highest taxable income was in the 35% bracket, then the deduction would reduce the overall tax bill by $350.

1 United States
2 Australia
3 United Kingdom
4 See also
5 References
6 External Links

[edit] United States

In the United States there are many different types of deductions. One may choose between a standard deduction or itemized deductions.

Some deductions are aimed at individuals; many are directed to businesses. The complicated maze of tax deductions that Congress has instituted over the past 70 years has contributed to the view that the tax code in the United States needs to be completely redone in a simpler fashion.

Opponents of the current tax code favor reducing or eliminating many existing tax deductions, particularly for corporations that have come to rely on the code as a welfare crutch. Reformers contend that the government should encourage spending on things like charities, home ownership, and education through means other than tax deductions.

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, and may have separately calculated limits (dollars or percent of expense or percent of AGI, etc), or be carried from one year to the next.

An exemption amount for the taxpayer, the spouse, each child, and any other qualified dependents, and certain disabilities;
Mortgage interest paid on one's primary residence or other residence;
Equity loan or Line of Credit interest;
Charitable contributions to eligible entities;
Business deductions, such as mileage, related to an individual's expenses regarding their employment;
Business startup and operation, and farming expenses (including travel, meals, and the so-called three-martini lunch), not to exceed business income;
Removal of architectural barriers to the disabled and elderly;
Union and professional dues;
Medical expenses above a certain percentage of the individual's Adjusted Gross Income (AGI);
The cost of tax advice, software, and books;
Depreciation of business assets;
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 not covered by casualty insurance;
Educational expense (but only if it does not prepare one for a new career);
The oil-depletion allowance or similar for depletion of timber and other natural resources, and reforestation expenses;
State and local taxes (i.e., income tax or property tax or use taxes);) in 2004 and 2005, one could choose between deducting State Sales Tax or alternatively deducting State Income Tax. This deduction was extended for two additional years in December of 2006. [2]
Capital losses (to a limit), such as from the sale of stock that has lost value, that exceed an individual taxpayer's capital gains in that year;
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 which levy an income tax. Each state government may allow additional types of expenditures to be tax-deductible, such as rent in lieu of mortgage.

Tax deductions start to "phase out" for married individuals, filing jointly, with an income of about $145,000 or higher (2005); 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.

[edit] Australia

While broadly similar, tax deductiblity in Australia differs from the United States in a number of key areas:

There are no State and Local (G3) income taxes.
Personal and Corporate taxation regimes are significantly different.
There is a tax free threshold (income up to this level is not taxed).
Income tax is charged at a higher rate for those on very large incomes.
While there is a small allowance for a dependent spouse, children are not tax deductible.
Loan interest payments on a primary residence (where one actually lives) is not deductible.
Business lunches (and similar expenses) are not deductible (incur Fringe Benefits Tax), but expenses on investment properties are.
Travel to/from work is not deductible.
Job search expenses are not deductible
In general terms, expenses incurred directly in pursuit of future profits from personal investment/business are tax deductible. This includes interest payments on a loan to buy shares, for example.

[edit] United Kingdom

Her Majesty's Revenue and Customs allow certain expenses to be deductible as necessary to complete the work from which the income was derived.

Examples of allowable expenses include:

Professional Subscriptions
Milage or other expenses incurred as part of the work
A proportion of home expenses where part of the home is used for work purposes (e.g. a self-employed person who works on a computer in the spare bedroom)