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What is an Income Deduction?

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  • Written By: Dale Marshall
  • Edited By: Kristen Osborne
  • Last Modified Date: 01 August 2018
  • Copyright Protected:
    2003-2018
    Conjecture Corporation
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The term “income deduction” is sometimes used to refer to a legal action like a garnishment designed to ensure support payments in divorce cases, but is used much more frequently, to describe the process by which taxpayers reduce the income on which they pay income tax. While the term "income tax deduction" is also popularly used to describe this process, it is inaccurate because the deductions are taken from income, not from tax.

In many countries, businesses and individuals alike who file returns and pay income taxes are generally permitted to make these adjustments. Deductions from income are permitted, for example, to account for the cost of producing the income as well as for purposes deemed politically or socially desirable by the government. Businesses are generally permitted to make an income deduction of the routine costs of doing business, such as rent, utilities and the cost of goods sold, as well as the salaries paid to employees, so that taxes are due and paid only on profits. Private taxpayers in the US are permitted to make many different income deductions, such as the interest expense paid toward a mortgage.

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Most industrialized nations utilize some form of progressive income tax to raise at least some of their operating funds. These systems are usually voluntary &emdash; that is, taxpayers generate and file income tax returns and pay the taxes due on their own, within government-set deadlines. Income tax returns will include a taxpayer's gross income, from which deductions are made, to determine the amount on which income tax is actually due.

In the US, the concept of reducing the amount of income on which tax is due is based on the idea that money spent producing income should be exempt from taxation &emdash; that is, if a merchant sells an item for $1,000, but it cost $700 to manufacture, promote and sell, then the amount that should be taxed is only $300. That merchant's income tax return would note the income of $1,000, and then each item included in the cost of earning that money would be listed as a separate income deduction, resulting in a balance of $300 on which tax is due.

Most of the deductions spelled out in the tax code reflect the cost of producing income. Other features of the US tax code designed to reduce income tax due, such as exemptions and tax credits, are not considered income deductions because they generally don't address money spent producing income.

Individual taxpayers in the US may deduct a wide variety of items from their gross income when calculating their tax liability. Although they can no longer deduct the interest expenses paid on loans except for certain education loans and the interest paid on real estate mortgages for their own personal residences, they may deduct amounts spent on many other different items. For example, a cash gift made to any of the thousands of recognized charities in the US is a legitimate income deduction, as is the value of non-cash items donated. Americans who change residences to move closer to a job can generally deduct the moving expenses from their income. Another very popular income deduction is business-related travel expenses &emdash; even if a sales trip is unsuccessful, the cost can be deducted the income subject to income tax.

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