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An Overview on Tax Deductions

Background Tax Deductions

Income tax deductions are a way of lowering the amount of a taxpayer's taxable income so that the total amount of taxes paid for that individual will ultimately be lowered, and is allowed for various items in which taxpayers incur expenses for. Tax deductions are often confused with tax credits, but they are two different concepts in American tax law.

A tax credit is a direct credit that reduces the total amount of taxes due from a taxpayer. This means that a person who owes $10,000 in taxes to the Internal Revenue Service, but receives a $1,000 credit, the taxpayer will have the total tax obligation reduced to just $9,000. A tax deduction, on the other hand, reduces the amount of taxable income to a certain extent and are usually limited to how much an expense exceeds a certain percentage of a taxpayer's income.

Purpose:

Tax deductions, along with tax credits is a system that was created by the United States government in order to reward and promote certain behavior or to encourage investment in specific types of property by taxpayers. For example, the government encourages taxpayers to donate to eligible charitable organizations and provides tax deductions for the amount that has been donated from a taxpayer.

Also, taxpayers that spend money on investments for a company, such as new factory equipment or brand new software may be eligible for itemized tax deductions for their monetary contributions to the economy. There are two means for calculating tax deductions in the United States.

The "regular tax" method determines a taxpayer's gross income, makes the necessary tax deductions and finally, a marginal tax percentage is applied based on the tax bracket of the individual. The "Alternative Minimum Tax" (AMT) is the second method of calculation, which uses a taxpayer's gross income, ignores certain tax preference items and applies a reduced amount of tax deductions.

Criticisms:

Tax deductions have been criticized over the years because many taxpayers believe that it is an anti-progressive system that favors taxpayers with higher incomes. This is because individuals with lower wages may not qualify for the benefits of the itemized tax deduction method, instead settling for the standard deduction method.

A person with a high salary, especially those with a six figure salary, will most likely be eligible for itemized tax deductions, given these individuals, what critics of the system call an unfair tax break unattainable by those in lower tax brackets. This has put doubt into the American system of progressive tax, which many believe negates the basic idea that the tax rate should increase when the amount of taxable income increases.

NEXT: A Helpful Overview on Tax Deductions

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