Tax Deductions: What They Are, How They Work, and Which Ones Apply in the U.S.

Tax deductions are one of the most widely used tools by taxpayers and businesses in the United States to reduce their tax burden. Through this mechanism, certain expenses or payments can be subtracted from gross income before calculating taxes owed, lowering the taxable base and, consequently, the overall tax liability.

While many people have heard about deductions without fully understanding how to apply them, knowing how they work can make the difference between overpaying or taking advantage of the legal benefits provided by the U.S. tax system. In this article, we explain in detail what deductions are, the most common types, how they’re applied, their limits, and key considerations when filing taxes.

What Is a Tax Deduction?

A tax deduction is an amount the Internal Revenue Service (IRS) allows you to subtract from your gross income before calculating the taxes you owe.

Simply put, it’s not money the government gives back to you, but a reduction of the income considered "taxable." For example, if your annual income is $70,000 and you claim $15,000 in deductions, your taxable income drops to $55,000. This means your tax bill is calculated on $55,000 rather than the full $70,000.
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Types of Tax Deductions

In the U.S., the tax system provides two main deduction paths: the standard deduction and itemized deductions. Taxpayers must choose whichever is most beneficial.

Standard Deduction

The standard deduction is a fixed amount updated annually for inflation. It’s designed to simplify tax filing for millions of taxpayers who don’t have significant deductible expenses.

• For 2025, the standard deduction is $14,600 for single filers and $29,200 for married couples filing jointly.
• Higher amounts apply if the filer is over 65 or visually impaired.
• Its main advantage is simplicity: no need to keep receipts or list individual expenses—just apply the standard amount.

Itemized Deductions

Instead of taking the standard deduction, taxpayers may choose to itemize eligible expenses allowed by the IRS. This option is best if deductible expenses exceed the standard deduction.

Common itemized deductions include:

• Mortgage interest on first or second homes.
• Charitable contributions to IRS-recognized organizations.
• Medical and dental expenses exceeding 7.5% of adjusted gross income (AGI).
• State and local taxes on income, sales, or property.
• Education expenses, including student loan interest.

Common Tax Deduction Categories in the U.S.

• State and Local Taxes (SALT): Deduction capped at $10,000 annually ($5,000 if married filing separately).
• Property Taxes: Allowed on real estate and certain personal property (cars, boats) if assessed fairly.
• Foreign Income Taxes: May be deducted or claimed as a tax credit.
• Charitable Donations: Deductible if made to qualified organizations, subject to income-based limits.
• Medical Expenses: Deductible if they exceed 7.5% of AGI, covering hospital bills, prescriptions, and transportation for medical care.
• Education Costs: Up to $2,500 in student loan interest annually, plus certain tuition-related deductions.

Deduction vs. Tax Credit

These terms are often confused but differ significantly:

• Deduction: Reduces taxable income. Example: a $1,000 deduction at a 22% tax rate saves you $220.
• Credit: Directly reduces the tax bill. A $1,000 credit saves you the full $1,000.
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Non-Deductible Taxes

Not all taxes are deductible. These include:

• Federal income tax.
• Social Security and Medicare taxes.
• Transfer taxes on property sales.
• Estate and inheritance taxes.
• Homeowners’ association fees.
• Utility charges such as water or garbage collection.

Limits and Considerations

• SALT deductions are capped at $10,000.
• Some expenses must exceed thresholds (e.g., medical expenses).
• Special rules apply for resident and nonresident aliens.
• If itemized deductions don’t exceed the standard deduction, it’s better to stick with the standard option.

FAQs About Tax Deductions

1. Should I choose the standard deduction or itemize?
It depends. If deductible expenses exceed the standard deduction, itemize; otherwise, the standard is simpler.

2. Can I deduct taxes paid abroad?
Yes, in some cases, but a foreign tax credit may be more beneficial.

3. What if I have high medical expenses?
If they exceed 7.5% of AGI, they can be deducted (doctor visits, prescriptions, insurance, transport).

4. Do businesses get deductions too?
Yes. Businesses can deduct ordinary and necessary expenses like salaries, rent, or equipment.

Why Tax Deductions Matter

Understanding and applying deductions properly is more than just reducing taxes—it’s about making smart financial decisions. Taxpayers should analyze whether to use the standard deduction or itemize based on IRS rules, income, and expenses.

For entrepreneurs operating in the U.S., deductions are crucial for planning, compliance, and maximizing profitability.

Next Steps with Openbiz

Navigating tax deductions is only one part of adapting to the U.S. business environment. If you’re expanding or starting a company in the U.S., you must also comply with legal, financial, and administrative requirements.

At Openbiz, we guide you through company formation, accounting, and tax management so you can operate with confidence. Our team ensures compliance while helping you optimize deductions and avoid overpaying.

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