What is a Deductible
Deductibles are the tax-deductible expenses subtracted from adjusted gross income. Deductibles reduce taxable income and thereby reduce the tax liability. A deductible is also the amount paid out-of-pocket for covered expenses before an insurance company will pay the remaining costs.
BREAKING DOWN Deductible
The Internal Revenue Service (IRS) considers several expenses as tax-deductible (also known as exempt income). The IRS divides tax-deductible expenses or deductions into two major categories, those for individuals, and those for businesses. Both types reduce the taxable income.
Established by the IRS, and reviewed annually, the standard deduction is subject to change. As of 2020, the standard deduction for single taxpayers and married persons filing separately is $12,400. For married persons filing jointly, the deduction is $24,800. And for Heads of Household filings, the deduction is $18,650. The deduction is subtracted directly from the adjusted gross income. As an example, if a single taxpayer reports $40,000 in taxable income, they may deduct $12,400 to lower their tax burden to $27,600.
Tax filers may opt to itemize their deductions if it provides a more substantial tax benefit. Taxpayers summarize and report eligible expenses on a tax return to reduce their taxable income. Examples of itemized deductions include but are not limited to charitable contributions, mortgage interest, and non-reimbursed, out-of-pocket medical and dental expenses, and some investment-related expenses. Brokerage account fees, such as commissions and trade-related fees are not deductible.
Business deductions work slightly different than individual deductions. Much like an individual, a business or self-employed individual must list all income. They may then deduct allowable expenses to arrive at the taxable income. Permissible deductions vary by the structure of the business. Limited Liability Companies (LLCs) and Corporations will have differences in the type and amount of deductions available to them.
Examples of ordinary deductible business expenses include operating expenses such as payroll, utilities, rent, leases, and other operational costs. Additional deductions include capital expenses, such as purchasing equipment or real estate.
As with all income tax items, the structure of allowable deductions changes frequently. What is permissible in one tax year, may not be deductible in the next.
Insurance deductibles are common to property, casualty, and health insurance products. Deductibles may be per occurrence or accumulate as an annual amount. Consider a health insurance claim where an insured person recently spent $2,000 in covered medical expenses and has a $300 annual deductible.The policyholder will pay $300, and the insurer will pay the remaining $1,700. Once meeting the annual deductible amount, the insurer covers the full costs for the rest of the year. Exceptions, such as co-payments and co-insurance, may apply.
In the United Kingdom, Australia, and some other parts of the world, an insurance deductible is referred to as an excess; however, the function the same.