What Is a Tax Deduction? Definition, vs. Credit, Example

What Is a Tax Deduction?

By Matthew Frankel, CFP – Updated Nov 19, 2024 at 10:59 AM

Key Points

Tax deductions lower taxable income; credits reduce tax owed directly.
Itemizing deductions is beneficial if total deductions exceed the standard amount.
IRA contributions are above-the-line deductions affecting gross taxable income.

To say that the United States tax code is complicated would be an understatement. It is almost 7,000 pages, and many of the tax laws we must follow have quite a bit of a gray area in their interpretation.

However, one of the silver linings to the thousands of pages of tax code is that there are numerous tax deductions and tax credits Americans can use. In this article, we'll cover the basics of tax deductions, how they work, and how they differ from credits and provide an example of how they might work in the real world.

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Safety scissors lying next to the word Taxes. — Image source: Getty Images.

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Below-the-line deductions. Taxpayers have two options with these deductions. They can choose to take the standard deduction amount available to everyone or list (itemize) each of their deductions. The most common examples of below-the-line tax deductions include mortgage interest, state and local taxes (also known as the SALT deduction), charitable contributions, and medical expenses exceeding 7.5% of your adjusted gross income.

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The Tax Cuts and Jobs Act roughly doubled the standard deduction, beginning with the 2018 tax year, and reduced the number of available deductions. As a result, the vast majority of taxpayers are better off with the standard deduction. The "big four" itemizable deductions are:

Mortgage interest on as much as $750,000 in qualified personal residence debt
Charitable contributions
State and local taxes, with a limit of $10,000 per year
Medical expenses exceeding 7.5% of adjusted gross income (AGI)

For most people, if these four deductions add up to more than your standard deduction amount, itemizing could be worth it. If not, you're probably better off taking the standard deduction.

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About the Author

Matt Frankel, CFP, is a contributing Motley Fool stock market analyst and personal finance expert covering financial stocks, REITs, SPACs, and personal finance. Prior to The Motley Fool, Matt taught high school and college mathematics. He holds a bachelor’s degree in physics from the University of South Carolina, a master’s degree in mathematics from Nova Southeastern University, and a graduate certificate in financial planning from Florida State University. He won a SABEW award for coverage of the 2017 Tax Cuts and Jobs Act. He is also regularly interviewed by Cheddar, The National Desk, and other TV networks and publications for his financial, stock market, and investing expertise.

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