'Tax Deductions' is explained in detail and with examples in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Tax Deductions prove to be a legal method for reducing income which the taxing authorities consider to be taxable. They typically arise because of expenses, especially such costs as taxpayers or businesses experience in the course of producing income or earning profits. This differs from exemptions and credits as both exemptions and deductions actually reduce the amount of income which can be taxed, while the credits applied actually reduce the total tax individuals and business will have to pay.
Two categories into which tax professionals often divide tax deductions are above the line and below the line. Above the line deductions benefit all taxpayers regardless of how much income they earn. Below the line ones only provide value if they surpass the individual taxpayers’ standard deductions. For 2016, this deduction turned out to be $6,400 for single taxpayers without families or dependents.
Tax deductions also differ according to business and personal types. For the United States, (as well as most business taxing jurisdictions), businesses may take both trade and business expenses off of their taxable income. These allowances vary widely from one type to another and are often restricted. In order to be permissible, said expenses have to be realized in the operations of the business on an activity the owners undertake in an effort to make profits.
Cost of goods sold is a nearly universally accepted tax deduction for most every system of income tax regardless of the jurisdiction. This reduces the gross income, and tax authorities typically consider it to be an expense. In the United States, the Internal Revenue Service permits “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business” as typical business tax deductions. These will be governed by any applicable limitations, enhancements, and qualifications.
Limitations do exist with regards to these types of business deductions. This is the case even though the necessary expenses may pertain directly to the business in question. Some of these limitations apply to activities which include lobbying expenditures, key employees’ compensation packages, the use of vehicles, and entertainment related to the business. Besides this, deductions which exceed the income of one enterprise can not necessarily offset income earned in other ventures. The U.S. limits those deductions from one passive activity to being used against income from another such passive activity.
Depreciation is another key tax deduction which the U.S. permits businesses and sole proprietors. This mechanism for cost recovery happens through deductions in the form of depreciation. It applies to most any tangible asset. The IRS permits such depreciation throughout the potential useful life of the asset, which they estimate.
The government assigns most depreciation (useful life) time-frames using the nature and utilization of such assets and the type of business as their guidelines. For example, they may allow three years of depreciation for tax deductions on a laptop or desktop computer. This means that the cost of the purchase can be divided by three and each resulting third of the price may be used as a specific tax deduction for three consecutive years.
Personal deductions are the other principal type of tax deductions. These pertain to individual taxpayers. Some intrinsically personal goods, costs, or services may be deducted from taxable income, per the IRS. The standard and set allowance for taxpayers and also some of their family members or dependents which they support is determined by the Internal Revenue Service and varies most every year.
The IRS calls these personal exemptions. In the United Kingdom and other British English-speaking jurisdictions throughout the world, these are known as personal allowances. In both types of systems, such exemptions and allowances become reduced and finally eliminated for those married couples or individuals whose income surpasses preset maximum levels.
Among the types of personal exemptions (which the U.S. and many other systems allow) are property taxes and local or state income taxes paid, medical costs, primary home loan interest charges, contributions to charitable organizations, contributions to either health savings or retirement savings plans, and some educational costs or interest paid on education-related student loans. The U.S. and Britain also allow payments to other individuals to become deducible in many cases, such as with child support or alimony.