Tax Deduction: What It Is and How It Works

Key takeaways
* A tax deduction reduces your taxable income, lowering the amount of tax you owe.
* Taxpayers choose either the standard deduction or to itemize deductions on Schedule A; you cannot do both in the same year.
* The Tax Cuts and Jobs Act (TCJA) increased the standard deduction and limited or eliminated many itemized deductions.
* Keep receipts and records for any itemized expenses in case the IRS requests substantiation.

What is a tax deduction?
A tax deduction is an allowance the IRS permits you to subtract from your gross income to arrive at taxable income. Lower taxable income usually means a smaller tax bill. Deductions can be taken either as a single standard deduction or by itemizing individual deductible expenses on Schedule A of Form 1040.

Standard deduction vs. itemized deductions
* Standard deduction: A fixed dollar amount you subtract from income. It simplifies filing because you don’t need to document expenses.
* Itemized deductions: The sum of eligible expenses (e.g., mortgage interest, charitable gifts, qualifying medical costs, certain state and local taxes) that you list on Schedule A. Itemize only if the total exceeds your standard deduction.

Note: Taxpayers who are 65 or older or blind can claim an additional standard deduction amount.

Common tax deductions
Common federal deductions include:
* Mortgage interest (subject to limits)
* State and local taxes (SALT), capped at a combined limit
* Charitable contributions
* Medical and dental expenses that exceed 7.5% of adjusted gross income (AGI)
* Student loan interest (subject to limits)
* Contributions to traditional IRAs and employer-sponsored plans (401(k), etc.)
* Contributions to Health Savings Accounts (HSAs)
* Self-employment expenses (home office, supplies, business use of vehicle, etc.)
* Certain investment losses and gambling losses (with restrictions)

Deductions affected by the TCJA
The 2017 Tax Cuts and Jobs Act nearly doubled the standard deduction and also eliminated or capped many itemized deductions (through 2025). Changes include:
* Mortgage interest deductible only on up to $750,000 of qualifying mortgage debt ($1 million for older loans originated before Dec. 16, 2017).
* SALT deduction capped (commonly referenced as $10,000 for state/local taxes).
* Elimination or limitation of deductions such as home-equity loan interest (except when used to improve the home), unreimbursed employee business expenses, certain moving expenses, and miscellaneous itemized deductions.

Deductions for the self-employed
Self-employed taxpayers retain several business-related deductions that wage employees often cannot claim:
* Deductible portion of self-employment tax (half of Medicare and Social Security tax)
* Home office deduction (must meet business-use rules)
* Self-employed health insurance premiums
* Retirement plan contributions (SEP IRA, SIMPLE IRA, solo 401(k)), which may be tax-deferred
Contributions to traditional IRAs and qualified retirement plans are generally above-the-line deductions that reduce taxable income even if you take the standard deduction.

Small business deductions
Businesses deduct ordinary and necessary business expenses, including:
* Advertising, travel, and business meals (subject to limits)
* Equipment and supplies
* Insurance, legal and professional fees
* Loan interest and business taxes
* Startup costs and continuing education
* Vehicle expenses (business portion only)
Rules can be complex; separate business and personal use carefully and keep supporting records.

Tax deductions vs. tax credits
* Deductions reduce taxable income.
* Credits reduce tax owed dollar-for-dollar and may be refundable (resulting in a refund if they exceed tax liability).
Because credits directly lower tax liability, they are generally more valuable than an equivalent deduction.

Example
Sarah, a single taxpayer with $50,000 gross income, has deductible items that total $15,500 (mortgage interest, SALT, charitable donations, qualifying medical expenses, and business expenses). For 2024 her standard deduction is $14,600. Because her itemized total ($15,500) exceeds the standard deduction, itemizing reduces her taxable income more than taking the standard deduction.

Limits and special rules
* Medical expenses: deductible only to the extent they exceed 7.5% of AGI (for 2024 and 2025).
* Mortgage interest: limited to qualified mortgage debt caps described above.
* SALT: capped at the statutory limit.
* Capital losses: you may deduct up to $3,000 of net capital losses against ordinary income per year ($1,500 if married filing separately); excess losses can be carried forward to later years.

Recordkeeping and documentation
If you itemize, keep receipts, invoices, canceled checks, and other records that substantiate your deductions. Retain documents for the period the IRS can audit (typically three years, but longer in some situations).

How to maximize deductions
* Contribute the maximum allowable to tax-deferred retirement accounts (traditional 401(k), traditional IRA) to reduce taxable income.
* Time deductible expenses (medical, charitable contributions, business purchases) in a single tax year if it helps you exceed the standard deduction and benefit from itemizing.
* For the self-employed and small-business owners, track all ordinary and necessary business expenses and use the appropriate tax forms and schedules.

Should I itemize or take the standard deduction?
Compare the total of your potential itemized deductions with the standard deduction for your filing status. Choose the option that produces the lower taxable income. You can change your choice from year to year as your situation changes.

Bottom line
Tax deductions lower taxable income and can meaningfully reduce your tax bill. Decide between the standard deduction and itemizing based on which yields the greater tax benefit. Maintain good records for any itemized expenses, stay aware of limits and recent law changes, and consult a tax professional for complex situations.