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 that is subject to income tax. It is often referred to as an allowable deduction.

Key Takeaways

  • Taxpayers who use the standard deduction may be able to file the abbreviated Form 1040-EZ.
  • Taxpayers who itemize deductions must use the longer Schedule A Form 1040 and list all of their allowable deductions.
  • The standard deductions for 2019 and 2020 are almost double the previous amounts.

For example, if you earn $50,000 in a year, and make a $1,000 donation to charity during that year, you are eligible to claim a deduction for that donation, reducing your taxable income to $49,000.

A deduction should not be confused with a tax credit.

  • A tax deduction reduces taxable income.
  • A tax credit reduces the amount of taxes owed. 

Understanding Deduction

Taxpayers in the United States have the choice of claiming the standard deduction or itemizing their deductions.

Claiming the standard deduction is easier. In fact, using the standard deduction allows for filers to send in the abbreviated Form 1040-EZ.

88%

The percentage of taxpayers who are expected to use the standard deduction in 2019 and 2020.

The taxpayer who itemizes deductions uses Schedule A Form 1040 and is 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, contributions to retirement accounts, 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 fully 88% of American taxpayers will take the standard deduction instead of itemizing in 2019 and 2020. The reason: The standard deduction has literally nearly doubled.

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

(Just for the sake of comparison, for tax year 2018, 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. These include eligible student loan interest and moving expenses.

Business Deductions

Small businesses don't get an EZ way to file their taxes. (Neither do large businesses, but they 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.

Deductions Vs. Credits

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 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, you receive a $100 tax refund.