What is a tax deduction? Definition and FAQs

Published Monday 13 October 2025

Table of contents

• Tax deductions (definition)
• Example of a tax deduction calculation
• Types of tax deductions for small business
• How to claim tax deductions
• Record keeping requirements
• Common tax deduction mistakes to avoid
• Managing tax deductions with Xero
• Handy resources
• FAQs on tax deductions

Key takeaways

• Keep detailed records of all business expenses throughout the year, including receipts, invoices, and documentation that proves the business purpose of each expense, as you must maintain these records for five years and cannot claim deductions without proper evidence.

• Separate business and personal portions of mixed-use expenses to ensure you only claim the legitimate business percentage, such as claiming 80% of a phone bill if you use your phone 80% for business purposes.

• Utilise accounting software to capture and categorise expenses as they occur, which helps you track all eligible deductions throughout the year and simplifies the claiming process at tax time.

• Consult with a tax professional or accountant to maximise your legitimate deductions while staying compliant with current tax laws and avoiding costly mistakes that could trigger ATO penalties.

Tax deductions definition

A tax deduction is a business expense that reduces your taxable income, so you pay less tax.

Tax deductions work by reducing your gross income to arrive at your taxable income. Common deductible expenses include:

• Office expenses: Rent, utilities, equipment, and supplies
• Business travel: Transport, accommodation, and meal costs
• Professional services: Insurance, legal fees, and accounting costs
• Marketing costs: Advertising, website expenses, and promotional materials

The Australian Taxation Office (ATO) sets the rules for which expenses you can claim and when.

Example of a tax deduction calculation

Tax deductions reduce your taxable income by subtracting legitimate business expenses from your total income.

Real-world example:Jo owns a photographic studio and earned $77,000 last year. She has $15,000 in deductible business expenses, which reduces her taxable income to $62,000.

$77,000 (gross income) - $15,000 (deductions) = $62,000 (taxable income)

Jo pays tax only on $62,000, not her full $77,000 income, so she saves money on tax.

Business purpose requirement

For an expense to qualify as a tax deduction, it must have a legitimate business purpose. A camera is deductible for a photographer but not for a baker.

Personal vs business expenses

• Personal expenses: Cannot be deducted (groceries, personal clothing)
• Mixed-use expenses: Claim only the business portion (80% business use = 80% deduction)
• Purely business expenses: Fully deductible when used exclusively for work

Record keeping essentials

Keep receipts for all expenses you plan to deduct. Proper documentation protects you during an Australian Taxation Office (ATO) audit and ensures you can claim legitimate deductions.

Types of tax deductions for small business

Check the latest guidance from the Australian Taxation Office (ATO) or speak with an advisor to make sure you claim the right expenses.

Work-related expenses

These are costs you incur to earn your income. They can include vehicle and travel expenses, self-education related to your work, and clothing and laundry for uniforms. Clothing deductions are only available in limited circumstances and must fit into specific categories.

Business operating costs

These are the day-to-day running costs of your business. Think of things like rent for your office, staff salaries, and office supplies. Some expenses may even qualify for special incentives, like a 20% bonus deduction on technology expenditure designed to help digitise your small business.

Home office deductions

If you work from home, you may be able to claim a portion of your household running expenses. Using the ATO's fixed rate method, for example, you can claim 70 cents for each hour you work from home, which covers costs like electricity, phone, internet, and the decline in value of office furniture.

How to claim tax deductions

Claiming deductions doesn't have to be complicated. It's about following a clear process and keeping good records throughout the year.

Follow these general steps to claim your deductions:

1. You must have spent the money yourself and weren't reimbursed.
2. The expense must directly relate to earning your income.
3. You need a record (like a receipt) to prove the expense.

Using accounting software to track deductions

Using accounting software helps you capture and categorise expenses as they happen, so you can claim all your eligible deductions at tax time.

Record keeping requirements

The Australian Taxation Office (ATO) requires you to keep records that prove your income and expenses. Good records make tax time smoother and protect you in case of an audit.

What records to maintain

You should keep records for all your business transactions. This includes invoices, receipts, bank statements, and contracts. For expenses, your records should show what you bought, when and where you bought it, and how it relates to your business.

How long to keep records

Generally, you need to keep your business records for five years from the date you lodge your tax return, as the ATO requires you to keep your written evidence for this period.

Digital vs physical records

You can keep records in paper or digital format. Digital records are easier to store, search and back up. Use software to snap photos of receipts and reduce paper clutter.

Common tax deduction mistakes to avoid

Knowing about common mistakes can help you claim with confidence at tax time.

Personal vs business expense confusion

You can only claim the business-use portion of an expense. If you use your car for both business and private trips, you need to separate the costs and only claim the business part.

Insufficient documentation

You can't claim a deduction if you don't have a record to prove it. Make sure you keep clear, organised records for all your claims.

Overclaiming risks

If you claim something you are not entitled to, you may face penalties. If you are unsure whether an expense is deductible, check the Australian Taxation Office (ATO) website or ask an accountant or bookkeeper.

Managing tax deductions with Xero

Using Xero accounting software makes it easy to capture every receipt and categorise every expense as it happens.

Ready to simplify your bookkeeping? Try Xero for free.

Handy resources

Tax deductions reduce your tax bill by lowering your taxable income. Tax laws change each year, so check the latest rules before you claim.

Getting professional help

Work with an accountant or tax agent to:

• Maximise legitimate deductions for your specific business situation
• Stay compliant with current tax law changes
• Avoid costly mistakes that could trigger ATO penalties

This professional guidance ensures you're claiming the right deductions while staying within legal requirements.

FAQs on tax deductions

Here are answers to some common questions about tax deductions.

Can you claim a $300 tax deduction without receipts?

For work-related expenses, you can claim up to $300 without receipts. According to the Australian Taxation Office (ATO), if your total claim for work-related expenses is $300 or less, you do not need full written evidence, but you must still be able to show how you calculated the claim if asked.

What's the difference between a tax deduction and a tax credit?

A tax deduction reduces your taxable income. A tax credit (or offset) directly reduces the tax you pay. Tax credits usually save you more than deductions.

Can I claim personal expenses as business deductions?

You can only claim the business portion of an expense. Personal expenses are not deductible.

How do I know if an expense is tax deductible?

An expense is usually deductible if it is necessary for earning your income and you have a record to prove it. The Australian Taxation Office (ATO) provides detailed guides for different industries, and a tax professional can give you advice for your situation.