Legal Definitions - deduction

In tax law, a deduction refers to an expense or amount that can be subtracted from an individual's or company's total income to arrive at a lower taxable income. By reducing the amount of income subject to tax, deductions effectively lower the overall tax liability. The specific types and amounts of deductions allowed are determined by tax laws and can vary based on whether the taxpayer is an individual or a business.

Here are some examples illustrating how deductions work:

• Home Mortgage Interest

  Imagine a homeowner, Sarah, who pays $15,000 in interest on her home mortgage over the course of a year. When she files her annual income tax return, she can often claim this eligible mortgage interest as a deduction.

  This illustrates a deduction because Sarah subtracts the $15,000 in mortgage interest from her total gross income. This reduces her taxable income, meaning the government calculates her tax bill based on a smaller income figure, ultimately lowering the amount of tax she owes.

• Student Loan Interest

  Consider David, a recent college graduate who is making payments on his student loans. During the year, he paid $1,200 in interest on these qualified loans.

  This demonstrates a deduction because David can subtract the $1,200 in student loan interest from his gross income. This lowers his adjusted gross income, which is the amount of income the tax authorities consider taxable, thereby reducing his overall income tax obligation for the year.

• Small Business Office Supplies

  Maria operates a small consulting business from her home. Throughout the year, she spends $800 on essential office supplies like printer ink, paper, and specialized software directly used for her business operations.

  This is an example of a deduction because Maria can subtract these $800 in legitimate business expenses from her total business revenue. By doing so, her net taxable business income is reduced, which in turn lowers the amount of income tax she has to pay on her business profits.