Tax deduction
A tax deduction or benefit is an amount deducted from taxable income, usually based on expenses such as those incurred to produce additional income. Tax deductions are a form of tax incentives, along with exemptions and tax credits. The difference between deductions, exemptions, and credits is that deductions and exemptions both reduce taxable income, while credits reduce tax.[1]
This article is about the deduction of expenses for the purpose of calculating taxable income. For tax deducted at source, see Withholding tax.Above and below the line[edit]
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.[2] 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.[1][3]
Limitations[edit]
Often, deductions are subject to conditions, such as being allowed only for expenses incurred that produce current benefits. Capitalization of items producing future benefit can be required, though with some exceptions. A deduction is allowed, for example, on interest paid on student loans.[1] Some systems allow taxpayer deductions for items the influential parties want to encourage as purchases.
Capitalized items and cost recovery (depreciation)[edit]
Many systems require that the cost of items likely to produce future benefits be capitalized.[26] Examples include plant and equipment, fees related to acquisition, and developing intangible assets (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 for costs of tangible assets[27] and as amortization 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.[28] The annual depreciation deduction may be computed on a straight line, declining balance, or other basis, as permitted in each country's rules.[29] 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.[30]
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."[31] This may be determined by reference to the type of asset or business.[32] Some systems allow specific charges for cost recovery for some assets upon certain identifiable events.[33]
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.[34] However, some systems provide for amortization of certain such costs, at the election of the taxpayer.[35]
Groups of taxpayers[edit]
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."[49] Generally, such deductions function in lieu of consolidated or combined computation of tax (tax consolidation) for such groups. Group relief may be available for companies in EU member countries with respect to losses of group companies in other countries.[50]
International aspects[edit]
Many systems impose limitations on tax deductions paid to foreign parties, especially related parties. See International tax and Transfer pricing.
Australia: Australian Taxation Office:
Canada:
United Kingdom: HM Revenue and Customs:
United States: Internal Revenue Service:
India: