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How do Tax Deductions Work?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 27 August 2016
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In order to understand how tax deductions work, it is necessary to understand the definition of a deduction. Essentially, a tax deduction is a legitimate expense that may be lawfully subtracted from the adjusted gross income for a given calendar period. Both individuals and businesses may claim tax deductions during the annual income tax reporting that is forwarded to federal, state, and in some cases local government revenue agencies.

The key to the process of claiming tax deductions is to have a firm grasp of what types of expenses may be claimed as tax deductible items. Since changes in tax laws and allowable deductible items occur on a continuing basis, it is important to keep abreast of both the type of tax deductions that may be claimed, as well as the percentage of the expense that can rightfully be exempted from taxable income.

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This will mean taking the time to look at each area of expense within a given situation. Individuals who currently carry a mortgage on a home will want to consult current revenue regulations and determine how much of the current year’s mortgage interest can be claimed as a deduction. Persons who operate a home business will want to make sure that the home office meets all the current criteria for being recognized as such before using this expense as a deduction. Businesses will want to look at the ratio between capital gains and losses to determine if there may be values in assets that can lawfully be deducted.

One of the biggest mistakes that people make with tax deductions is making the assumption that if an expense was deductible last year that it is OK to deduct the expense for the current year. Often, this will be the case. However, some recurring expenses will depreciate in the amount that can be deducted with each passing year. It is important to keep on top of whether or not an expense is deductible this year, and if so, how much of the expenses qualify.

Some individuals and businesses find that deducting from taxes is a task that requires both time and effort to accomplish properly. For this reason, professional tax accountants often are provided with all pertinent documents, and the job of determining the tax deductions for the period is left with them. However, the individual or business who chooses to outsource his or her tax return should understand that the government will hold the taxpayer accountable for the final version of the tax return. For this reason, it is a good idea to understand all laws regarding tax deductions and to check your return thoroughly before submitting the completed forms to the proper revenue agency.

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