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Pre-tax deductions are expenses taxpayers can deduct from their taxable income in order to lower their overall tax burden. Laws specifying which items taxpayers can write off vary from country to country, but typically pre-tax deductions include education expenses, retirement account contributions, and health care costs. Many countries have tiered systems for income tax, and the ability to deduct expenses enables many taxpayers to fall into lower tax brackets.
Governments offer taxpayers the ability to make pre-tax deductions to encourage people to fund necessary expenses, such as healthcare. In the United States, people must pay for their own private health insurance, although many employers share the cost. The federal government allows taxpayers to write-off health insurance premiums as well as contributions made to flexible spending accounts, from which consumers draw funds to cover the cost of prescriptions and doctor visit co-pays.
Many nations allow both consumers and business entities to deduct contributions made to retirement accounts. Businesses often save money by funding employee’s retirement accounts because of the pre-tax deductions. In the United States, many companies allow employees to enroll in 401(k) retirement accounts, which are partially funded by both the employer and the employee. Contributions are not only made on a pre-tax basis, but funds invested grow tax deferred, so people only pay federal income tax when they begin to make account withdrawals during their retirement years. The same tax benefits are afforded to taxpayers who establish Individual Retirement Accounts (IRA), which often involve no employer contributions.
Home owners are often able to use premiums paid for homeowners' insurance and charges related to mortgage interest as tax write-offs. Investors who own multiple rental properties can typically only write off taxes and insurance costs related to their primary home. Business tax laws do allow some investors to write off business expenses, and in some countries interest payments on investment property loans are classified as business expenses. Other common business related deductions utilized by self-employed people include vehicle maintenance costs, advertising expenses, and charges related to entertaining clients.
Pre-tax deductions are not available to everyone. High earners are often unable to claim deductions for retirement plan contributions and health care costs, and in the United States many high earners have to pay the Alternative Minimum Tax (AMT), which is designed to make people with above average income pay federal taxes. Most countries have some kind of income restrictions on pre-tax deductions.