Tax deduction is a reduction of income that is able to be
tax A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity In law Law is a system A system is a group of Interaction, interacting or interrelated elements that act accord ...
ed and is commonly a result of expenses, particularly those incurred to produce additional income. Tax deductions are a form of
tax incentives A tax incentive is an aspect of a country's tax code designed to incentive, incentivize or encourage a particular economic activity by reducing tax payments for a company in the said country. Tax incentives can have both positive and negative imp ...
, along with exemptions and
credits Credit refers to any form of deferred payment, the granting of a loan and the creation of debt. Credit may also refer to: Places * Credit, Arkansas, a ghost town Arts, entertainment, and media * Credit (creative arts), acknowledging the ideas o ...
. The difference between deductions, exemptions and credits is that deductions and exemptions both reduce taxable income, while credits reduce tax.

Above and below the line

Above and below the line refers to items above or below adjusted gross income, which is item 37 on the tax year 2017 1040 tax form. Tax deductions above the line lessen adjusted gross income, while deductions below the line can only lessen taxable income if the aggregate of those deductions exceeds the standard deduction, which in tax year 2018 in the U.S., for example, was $12,000 for a single taxpayer and $24,000 for married couple.


Often, deductions are subject to conditions, such as being allowed only for expenses incurred that produce current benefits.
Capitalization Capitalization (North American English North American English (NAmE, NAE) is the most generalized variety (linguistics), variety of the English language as spoken in the United States and Canada. Because of their related histories and cultur ...
of items producing future benefit can be required, though with some exceptions. A deduction is allowed, for example, on interest paid on student loans. Some systems allow taxpayer deductions for items the influential parties want to encourage as purchases.

Business expenses

Nearly all jurisdictions that tax business income allow deductions for business and trade expenses. Allowances vary and may be general or restricted. To be deducted, the expenses must be incurred in furthering business, and usually only include activities undertaken for profit.

Cost of goods sold

Nearly all income tax systems allow a deduction for the
cost of goods sold Cost of goods sold (COGS) is the carrying value In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization ...
. This may be considered an expense, a reduction of
gross income For households and individuals, gross income is the sum of all wages A wage is the distribution from an employer Employment is the relationship between two party (law), parties, usually based on a employment contract, contract where work ...
, or merely a component utilized in computing net profits. The manner in which cost of goods sold is determined has several inherent complexities, including various accounting methods. These include: *Conventions for assigning costs to particular goods sold where specific identification is infeasible. *Methods for attributing common costs, such as factory burden, to particular goods. *Methods for determining when costs are recognized in computing cost of goods sold or to be sold. *Methods for recognizing costs of goods that will not be sold or have declined in value.

Trading or ordinary and necessary business expenses

Many systems, including the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain,Usage is mixed. The Guardian' and Telegraph' use Britain as a synonym for the United Kingdom. Some prefer to use Britain as shorth ...

United Kingdom
, levy tax on all chargeable “profits of a trade” computed under local
generally accepted accounting principles Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms opera ...
(GAAP). Under this approach, determination of whether an item is deductible depends upon accounting rules and judgments. By contrast, the U.S. allows as a deduction "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business..." subject to qualifications, enhancements, and limitations. A similar approach is followed by Canada, but generally with fewer special rules. Such an approach poses significant definitional issues. Among the definitional issues often addressed are: *What constitutes a trade or business? Generally, the business must be regular, continuous, substantial, and entered into with an expectation of profit. *What expenses are ordinary and necessary? The phrase deals with what expenses are appropriate to the nature of the business, whether the expenses are of the sort expected to help produce income and promote the business, and whether the expenses are not lavish and extravagant. Note that under this concept, the same sorts of expenses are generally deductible by business entities and individuals carrying on a trade or business. To the extent such expenses relate to the employment of an individual and are not reimbursed by the employer, the amount may be deductible by the individual. Business deductions of flow-through entities may flow through as a component of the entity's net income in some jurisdictions. Deductions of flow-through entities may pass through to members of such entities separately from the net income of the entity in some jurisdictions or some cases. For example, charitable contributions by trusts, and all deductions of partnerships (and
S corporations An S corporation, for Income tax in the United States, United States federal income tax, is a closely held corporation (or, in some cases, a limited liability company (LLC) or a Partnership taxation in the United States, partnership) that makes a ...
in the U.S.) are deductible by member beneficiaries or partners (or
S corporation An S corporation, for United States federal income tax, is a closely held corporation (or, in some cases, a limited liability company A limited liability company (LLC) is the United States of America, US-specific form of a private limited ...
shareholders) in a manner appropriate to the deduction and the member, such as itemized deductions for charitable contributions or a component of net business profits for business expenses.

Accounting methods

One important aspect of determining tax deductions for business expenses is the timing of such deduction. The method used for this is commonly referred to as an accounting method. Accounting methods for tax purposes may differ from applicable GAAP. Examples include timing of recognition of cost recovery deductions (e.g., depreciation), current expensing of otherwise capitalizable costs of intangibles, and rules related to costs that should be treated as part of cost of goods not yet sold. Further, taxpayers often have choices among multiple accounting methods permissible under GAAP and/or tax rules. Examples include conventions for determining which goods have been sold (such as first-in-first-out, average cost, etc.), whether or not to defer minor expenses producing benefit in the immediately succeeding period, etc. Accounting methods may be defined with some precision by tax law, as in the U.S. system, or may be based on GAAP, as in the UK system.

Limits on deductions

Many systems limit particular deductions, even where the expenses directly relate to the business. Such limitations may, by way of example, include: *Maximum deductions for use of automobiles *Limits on deducting compensation of certain key employees *Limits on lobbying or similar expenditures *Nondeductibility of payments considered in violation of public policy, such as criminal fines *Limits on deductions for business-related entertainment but no limit in 2021 taxes and beyond. In addition, deductions in excess of income in one endeavor may not be allowed to offset income from other endeavors. For example, the United States limits deductions related to passive activities to income from passive activities. In particular, expenses that are included in COGS cannot be deducted again as a business expense. COGS expenses include: * The cost of products or raw materials, including freight or shipping charges; * The cost of storing products the business sells; * Direct labor costs for workers who produce the products; and * Factory overhead expenses. In 2005, the Australian government amended its taxation legislation to remove deductions for expenses incurred in conducting criminal business activities. This came after the
Federal Court Federal court may refer to: United States * Federal judiciary of the United States ** United States district court, a particular federal court Elsewhere * Federal Court of Australia * Federal courts of Brazil * Federal Court (Canada) * Federal Cou ...
ruled in '' Commissioner of Taxation v La Rosa'' that a heroin dealer was entitled to a tax deduction for money stolen from him in a drug deal.

Capitalized items and cost recovery (depreciation)

Many systems require that the cost of items likely to produce future benefits be capitalized. Examples include plant and equipment, fees related to acquisition, and developing
intangible asset An intangible asset is an asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economi ...
s (e.g., patentable inventions). Such systems often allow a tax deduction for cost recovery in a future period. A common approach to such cost recovery is to allow a deduction for a portion of the cost ratably over some period of years. The U.S. system refers to such a cost recovery deduction as
depreciation In accountancy, depreciation refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the allocation in a ...

for costs of tangible assets and as
amortization Amortization (or amortisation; ) is paying off an amount owed over time by making planned, incremental payments of principal Principal may refer to: Title or rank * Principal (academia) The principal is the chief executive and the chief academ ...
for costs of intangible assets. Depreciation in these systems is allowed over an estimated useful life, which may be assigned by the government for numerous classes of assets, based on the nature and use of the asset and the nature of the business. The annual depreciation deduction may be computed on a straight line, declining balance, or other basis, as permitted in each country's rules. Many systems allow amortization of the cost of intangible assets only on a straight-line basis, generally computed monthly over the actual expected life or a government specified life. Alternative approaches are used by some systems. Some systems allow a fixed percentage or dollar amount of cost recovery in particular years, often called “capital allowances.” This may be determined by reference to the type of asset or business. Some systems allow specific charges for cost recovery for some assets upon certain identifiable events. Capitalization may be required for some items without the potential for cost recovery until disposition or abandonment of the asset to which the capitalized costs relate. This is often the case for costs related to the formation or reorganization of a corporation, or certain expenses in corporate acquisitions. However, some systems provide for amortization of certain such costs, at the election of the taxpayer.

Non-business expenses

Some systems distinguish between an active trade or business and the holding of assets to produce income. In such systems, there may be additional limitations on the timing and nature of amounts that may be claimed as tax deductions. Many of the rules, including accounting methods and limits on deductions, that apply to business expenses also apply to income producing expenses.


Many systems allow a deduction for loss on sale, exchange, or abandonment of both business and non-business income producing assets. This deduction may be limited to gains from the same class of assets. In the U.S., a loss on non-business assets is considered a capital loss, and deduction of the loss is limited to capital gains. Also, in the U.S. a loss on the sale of the taxpayer's principal residence or other personal assets is not allowed as a deduction except to the extent due to casualty or theft.

Personal deductions

Many jurisdictions allow certain classes of taxpayers to reduce taxable income for certain inherently personal items. A common such deduction is a fixed allowance for the taxpayer and certain family members or other persons supported by the taxpayer. The U.S. allows such a deduction for “personal exemptions” for the taxpayer and certain members of the taxpayer's household. The UK grants a “
personal allowance In the UK tax system, personal allowance is the threshold above which income tax An income tax is a tax A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity In law ...
.” Both U.S. and UK allowances are phased out for individuals or married couples with income in excess of specified levels. In addition, many jurisdictions allow reduction of taxable income for certain categories of expenses not incurred in connection with a business or investments. In the U.S. system, these (as well as certain business or investment expenses) are referred to as "
itemized deductions Under United States tax law The United States of America The United States of America (USA), commonly known as the United States (U.S. or US), or America, is a country Contiguous United States, primarily located in North America. It consi ...
" for individuals. The UK allows a few of these as personal reliefs. These include, for example, the following for U.S. residents (and UK residents as noted): *Medical expenses (in excess of 7.5% of adjusted gross income) *State and local income and property taxes (the SALT deduction in the United States) *Interest expense on certain home loans *Gifts of money or property to qualifying charitable organizations, subject to certain maximum limitations, *Losses on non-income-producing property due to casualty or theft, *Contribution to certain retirement or health savings plans (U.S. and UK), *Certain educational expenses. Many systems provide that an individual may claim a tax deduction for personal payments that, upon payment, become taxable to another person, such as alimony. Such systems generally require, at a minimum, reporting of such amounts, and may require that
withholding tax Tax withholding, also known as tax retention, Pay-as-You-Go, Pay-as-You-Earn, or a ''Prélèvement à la source'', is income tax An income tax is a tax imposed on individuals or entities (taxpayers) in respect of the income or profits earned by t ...
be applied to the payment.

Groups of taxpayers

Some systems allow a deduction to a company or other entity for expenses or losses of another company or entity if the two companies or entities are commonly controlled. Such deduction may be referred to as “group relief.” Generally, such deductions function in lieu of consolidated or combined computation of tax (
tax consolidation Tax consolidation, or combined reporting, is a regime adopted in the tax or revenue legislation of a number of countries which treats a group of wholly owned or majority-owned companies and other entities (such as trusts and partnerships) as a sing ...
) for such groups. Group relief may be available for companies in EU member countries with respect to losses of group companies in other countries.See, e.g.
UK draft guidance
following the
Marks & Spencer Marks and Spencer Group plc (commonly abbreviated to M&S and colloquially known as Marks's or Marks & Sparks) is a major British multinational retailer with headquarters in London, England, that specialises in selling clothing, home products a ...

International aspects

Many systems impose limitations on tax deductions paid to foreign parties, especially related parties. See
International tax International taxation is the study or determination of tax A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity In law, a legal person is any person A person (plural peopl ...
Transfer pricing In taxation and accounting, transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. Because of the potential for cross-border controlled transactions to distort ...


Further reading

*Crowningshield, Gerald, and Gorman, Kenneth: Cost Accounting, * Horngren, Charles T., ''et al.'': Cost Accounting, *Hoffman, William, ''et al.'': Individual Income Taxes (annual editions; 2011 edition ) *Pratt, James, and Kulsrud, William: 2010 Federal Taxation, *Whittenberg, Gerald, and Altus-Buller, Martha: Income Tax Fundamentals, *Schneider, Leslie: Federal Income Taxation of Inventories *Weltman, Barbara: ''J.K.Lasser's 1001 Deductions …'',

External links

Australian Taxation Office The Australian Taxation Office (ATO) is an Australian statutory agency and the principal revenue collection body for the Australian Government. The ATO has responsibility for administering the Taxation in Australia, Australian federal taxation sy ...
Main site
Canada Revenue Agency The Canada Revenue Agency (CRA; ) is the revenue service of the Government of Canada. The CRA collects Taxation in Canada, taxes, administers tax law and tax policy, policy, and delivers Welfare, benefit programs and tax credits for the federal gov ...
Main site

United Kingdom:
HM Revenue and Customs , type = Non-ministerial government department Non-ministerial government departments (NMGDs) are a type of Departments of the Government of the United Kingdom, department of the Government of the United Kingdom that deal with matters for whic ...
Main site

United States:
Internal Revenue Service The Internal Revenue Service (IRS) is the revenue service A revenue service, revenue agency or taxation authority is a government agency responsible for the intake of government revenue, including taxes and sometimes non-tax revenue. Depe ...
Main site
*Some relevan

Business expenses: Tax Guide for Small Business
Travel and entertainment deductions
Exemptions and standard deduction
Miscellaneous deductions
Business Expenses
Home mortgage interest
Depreciation *A few relevant forms (also see related instructions)
Form 1040
(individual tax return), Schedules C (business) and E (rental)
Form 1065
(partnership return of income), page 1, and Schedule K
Form 1120
(corporation tax return), page 1
Form 2106
(employee business expenses)
Form 4562
(depreciation and amortization)
Form 4797
(gain or loss on business assets)
Form 8825
(rental realty income) India:
Official page of Indian Income-tax e-Filing portal
{{Authority control Tax terms