Tax deduction (tax write-off)
An amount subtracted from income before tax is calculated, which lowers the income the tax applies to. In everyday speech it is often called a tax write-off.
In short
- A deduction lowers the income tax is charged on. A credit lowers the tax itself.
- A deduction saves its amount times your tax rate, not its full amount.
- Business expenses are the main deductions for a business, and each one needs a record behind it.
A tax deduction is an amount you subtract from your income before the tax on it is worked out. The IRS describes it as an amount you subtract from your income so you don't pay tax on it. In everyday speech, a deduction is often called a tax write-off, and writing off a purchase means claiming it as a deduction.
What is a tax write-off?
A write-off and a deduction are the same thing. When a freelancer says they can write off a laptop, they mean the business share of its cost reduces their taxable income. It does not mean the purchase is free. A deduction saves its amount multiplied by your tax rate: a $1,000 deduction at a 25% rate saves $250, not $1,000.
Deductions versus credits
A credit is subtracted from the tax itself, not from income. That makes a credit worth its full amount, while a deduction is worth its amount times your rate. In the US, most people take the standard deduction, a set amount based on filing status, and itemize only when their eligible expenses add up to more. In Canada, deductions such as RRSP contributions lower your net income, and non-refundable tax credits, such as the basic personal amount, lower the tax calculated on it.
Business deductions
For a business or a self-employed person, most deductions are business expenses: rent, supplies, software, travel, advertising and professional fees. The IRS allows expenses that are ordinary and necessary, and the CRA allows reasonable expenses incurred to earn business income. Personal costs are not deductible, and a cost used for both is deductible only for its business share. Capital purchases are written off over several years rather than all at once.
Proof
A deduction you cannot support can be disallowed. Keep the receipt or invoice for each expense, showing who you paid, when, how much and for what. A few deductions accept other records instead; our guide to deductions you can claim without receipts lists them.
Worked example
What a $3,000 write-off is worth
A business owner whose income is taxed at a 22% marginal rate spends $3,000 on software and supplies that are fully deductible this year. Their taxable income falls by $3,000 and their income tax by $660. The other $2,340 is still money they spent. A $3,000 tax credit, by contrast, would have cut the tax bill by the full $3,000.