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Deduction

A deduction is an expense that is subtracted from your taxable income on your federal income tax return.

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Expanded Definition

For businesses, a wide variety of expenses can be deducted from sales as a business expense. Individuals are encouraged to use the minimum standard deduction when filing their income tax return. Hence, many find the standard deduction more attractive than itemized deductions. The most common deductions that allow you to itemize include property taxes, mortgage interest, and state income taxes paid.

Itemized deductions are claimed on Schedule A of Form 1040. Other deductions reported there include charitable contributions or gifts, casualty and theft losses, unreimbursed employee expenses, tax preparation fees, and investment expenses. Medical and dental expenses (but not health insurance premiums) are deductible if they exceed 7.5% of AGI.

Certain expenses are deducted directly from income on lines 23 to 35 of Form 1040 to arrive at AGI. They do not require itemization. The most common ones are IRA deductions and alimony paid. Others include health savings account contributions, moving expenses, tuition, student loan interest, etc.

In considering deductible expenses, one should note that the deductible is multiplied by your tax rate to arrive at the income tax paid or saved. As many of us pay tax rates of 25% or less, the amount saved on taxes can be small. For example, donation of a $2000 automobile to a charity will result in a $500 reduction in income taxes in the 25% bracket. Most would be wiser to sell the vehicle than give it to charity.

Compare: tax credit

Some states may allow deductions on their state income tax returns.

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