Tax deduction

From Free net encyclopedia

A tax deduction or a tax-deductible expense represents an expense incurred by a taxpayer that is subtracted from gross income and results in a lower overall taxable income.

The U.S. income tax system is progressive; as taxable income rises, a higher percentage is charged on a tiered system. E.g., in 2005 for Single taxpayers, the first $7,300 of taxable income is charged 10 percent; however, if a person has more than $7,300 in taxable income, then he or she must pay a flat $730 (10 percent of the first $7,300), plus 15% of the amount over 7,300. The next progressive tier is reached at $29,700; the percentage that is charged goes up again (to 25%) for taxable incomes above $29,700.

Because tax deductions reduce taxable income, and taxes owed are a percentage of taxable income, then tax deductions offer a fractional reduction in taxes owed. I.e., tax deductions do not reduce taxes owed on a dollar for dollar basis. Tax credits, however, do.

As an example, if a person's highest portion of taxable income is taxed at 25% (progressive scale from 10 to 35 percent), then a $1,000 charitable contribution, will result in a reduced tax bill of $250 (25% of the contribution). E.g., if a taxpayer would otherwise have owed the federal government $3,250 in income taxes; the new tax bill would be $3,000. As a second example, if a person was charged an early withdrawal penalty of $1000 for breaking a banking certificate of deposit (CD) before maturity, and that person's highest taxable income was in the 35% bracket, then the deduction would reduce the overall tax bill by $350.

The U.S. tax code is filled with tax deductions; some are aimed at individuals, while many are aimed at businesses. The totality of the tax deductions that Congress has instituted over more than seven decades has greatly contributed to the tax code being viewed by most as needing a tremendous overhaul.

Opponents of the current tax code favour reducing or eliminating many existing tax deductions, particularly for corporations that have come to rely on the code as a welfare crutch. Reformers contend that the government should encourage spending on things like charities, home ownership, and education through means other than tax deductions.

Contents 1 United States 2 Australia 3 See also 4 References

United States

In the United States there are many types of deductions. The number and complexity of the amendments has often led to a call for tax reform, to simplify the tax code, at the very least. One may choose between a standard deduction or itemized deductions.

Common examples of tax deductions for individuals follow. Each of these deductions may or may not be appropriate, given a taxpayer's filing status, income, and so forth, and may have separately calculated limits (dollars or percent of expense or percent of AGI, etc), or be carried from one year to the next.

• An exemption amount for the taxpayer, their spouse, each child, and any other qualified dependents, and certain disabilities;
• Mortgage interest paid on one's primary residence;
• Equity loan or Line of Credit interest;
• Charitable contributions to eligible entities;
• Business deductions relate to an individual's expenses related to employment;
• Business startup and operation, and farming expenses (including travel, meals, and the so-called three-martini lunch), not to exceed business income;
• Removal of architectural barriers to the disabled and elderly;
• Union and professional dues;
• Medical expenses above a certain percentage of the individual's Adjusted Gross Income (AGI);
• The cost of tax advice, software, and books;
• Depreciation of business assets;
• Work uniforms and clothing, including such items as safety goggles or steel-toed shoes;
• Moving expenses, in some cases;
• Job search expenses as one searches for work in the same industry;
• Casualty (fire, theft) losses not covered by casualty insurance;
• Educational expense (but only if it does not prepare one for a new career);
• The oil-depletion allowance or similar for depletion of timber and other natural resources, and reforestation expenses;
• State and local taxes (i.e., income tax or property tax, but not sales or use taxes);
• Capital losses (to a limit), such as from the sale of stock that has lost value, that exceed an individual taxpayer's capital gains in that year;
• Gambling losses (but not in excess of gambling winnings).

All tax deductions allowed by the federal government are also allowed by all the state governments which levy an income tax. Each state government may allow additional types of expenditures to be tax-deductible, such as rent in lieu of mortgage.

Tax deductions start to "phase out" for married individuals, filing jointly, with an income of about $145,000 or higher (2005); beyond that point, the full amount of the expenses cannot be deducted.

Corporations enjoy a wider range of possible tax deductions, as they are taxed on their income, and in order to calculate a corporation's income, the corporation simply subtracts its expenses from its revenues. Hence, all expenses of the business -- if the expenses can be demonstrated to have been made for business purposes -- are tax deductible.

Comedian Al Franken once did a skit on Saturday Night Live in which he purported to demonstrate the creative use of tax deductions. Among other things, Franken held up a picture of himself on vacation in Hawaii. Since he used the photo in the comedy routine in his professional capacity as a comedian, the entire cost of his trip was (allegedly) deductible. Whether Franken actually took such a deduction, or whether he got away with it, is unknown.

Australia

While broadly similar, tax deductiblity in Australia differs from the United States in a number of key areas:

• There are no State and Local (G3) income taxes.
• Personal and Corporate taxation regimes are significantly different.
• There is a tax free threshold (income up to this level is not taxed).
• Income tax is charged at a higher rate for those on very large incomes.
• While there is a small allowance for a dependent spouse, children are not tax deductible.
• Interest on home-loans (Mortgages etc) is not deductible.
• Business lunches (and similar expenses) are not deductible.
• Travel to/from work is not deductible.
• Job search expenses are not deductible
• Generally the higher one's income the more deductions one may take advantage of.

See also

• Tax credit

References

• 26 US Code §§ 161 to 198 (Part VI Itemized Deductions)