Tax deduction
Also called tax write-off
An amount subtracted from income before tax is calculated; its value equals the deduction times the taxpayer’s marginal tax rate.
What it means
A tax deduction lowers taxable income, which in turn lowers tax. Some deductions reduce AGI (adjustments such as deductible IRA contributions), others are taken as either the standard deduction or itemized deductions, and some business owners can deduct a share of qualified business income.
Because a deduction reduces income rather than tax directly, its dollar value depends on the marginal tax rate: the same deduction is worth more to someone in a higher bracket. That makes a deduction different from a tax credit, which reduces the tax bill dollar for dollar.
Formula
Tax saved = Deduction amount × Marginal tax rate
- Deduction amount = dollars subtracted from taxable income
- Marginal tax rate = rate on the last dollar of income
Example
Suppose someone with a hypothetical 20% marginal rate has a $1,000 deduction. Their taxable income falls by $1,000 and their tax falls by $200. A $1,000 tax credit, by contrast, would cut their tax by the full $1,000.
How it’s used
- Reducing taxable income
- Comparing the value of deductions and credits
- Planning retirement or HSA contributions
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.