What is a tax deduction?

A tax deduction is defined as an expense that reduces taxable income. When individuals or businesses incur certain expenses that the tax laws recognize, these expenses can be subtracted from their total income, resulting in a lower amount of income that is subject to taxation. This means that taxpayers only pay taxes on the income left after these deductions are accounted for, effectively lowering the overall taxable income and potentially lowering their tax bill.

Understanding how tax deductions work is essential in financial literacy, as effective tax planning can lead to significant savings. For instance, common deductions may include expenses for education, healthcare, mortgage interest, and certain business expenses. Properly using deductions can therefore incentivize taxpayers to engage in activities that have beneficial impacts on the economy or their well-being.

The other options do not accurately represent a tax deduction—some pertain to different tax concepts such as additions to taxable income or tax credits, which function to reduce tax liability instead of taxable income.