What Is a Deduction?

A deduction is an expense that can be subtracted from an individual or married couple's gross income in order to reduce the amount of income tax they are liable to pay.

For example, if you earn $50,000 in a year, and make a $1,000 donation to charity during that period, you are eligible to claim a deduction for that donation, reducing your taxable income to $49,000. A deduction is often referred to as an allowable deduction.

Key Takeaways

  • A deduction is an expense that can be subtracted from an individual or married couple's gross income to reduce their total amount of taxable income.
  • Many taxpayers taking the standard deduction will only need to file Form 1040 and few additional schedules.
  • Taxpayers who itemize deductions must use Schedule A Form 1040 and list all of their allowable deductions.
  • The standard deductions for 2019 and 2020 are almost double the previous amounts.

Understanding a Deduction

Taxpayers in the United States have the choice of claiming the standard deduction or itemizing their deductions. Claiming the standard deduction is easier and simply requires checking a box on your tax return. In fact, the Internal Revenue Service (IRS) has revamped the Form 1040, which most taxpayers will now use, and retired the old 1040A and 1040EZ forms.

88.6%

The percentage of taxpayers who were expected to use the standard deduction for the 2019 tax year.

Taxpayers who itemize deductions must use Schedule A Form 1040, an optional attachment to the standard 1040 form, and are required to fill in a list of allowable deductions, and keep receipts to prove them if they are audited.

This longer form is used by filers who have substantial deductions that add up to more than the standard deduction. Common itemized deductions include interest on a mortgage loan, uncovered healthcare costs, state and local taxes, and charitable contributions.

Standard Deduction vs. Itemized Deductions

The U.S. Congress' Joint Committee on Taxation estimates that 139.4 million American taxpayers will take the standard deduction instead of itemizing for the 2019 tax year. Why? Because the standard deduction has literally nearly doubled.

  • For the 2019 tax year, the standard deduction was set at $12,200 for individuals, $18,350 for heads of household, and $24,400 for married couples filing jointly and surviving spouses.
  • For the 2020 tax year, the standard deduction was set at $12,400 for singles, $18,650 for heads of household, and $24,800 for married couples filing jointly and surviving spouses.

These allowances mark a significant upgrade on the 2017 tax year when the standard deduction was $6,350 for single filers and $12,700 for married people filing jointly.

If you opt to claim the standard deduction, there are still some itemized deductions you can claim on your income tax return, including eligible student loan interest and tuition and fees.

Deductions vs. Credits

A deduction should not be confused with a tax credit. A tax credit is subtracted from the amount of tax you owe, not from your reported income. The IRS has both refundable and non-refundable credits. Non-refundable credits cannot trigger a tax refund, but refundable credits can.

For example, imagine that after reporting your income and claiming your deductions you owe $500 in income tax. However, you are also eligible for a $600 credit. If the credit is non-refundable, your tax bill is erased but you do not receive any extra money. If the credit is refundable, on the other hand, you receive a $100 tax refund.

Special Considerations

Business Deductions

Small businesses don't get an easy way to file their taxes—and neither do large businesses, although they at least have accounting departments.

Businesses are required to report all of their gross income, and then deduct all of their business expenses from it. The difference is net taxable income. Thus, business expenses work in a way that is similar to deductions.