What are tax deductions?

Published Thursday 23 July 2026

Table of contents

• What are tax deductions?
• How do tax deductions work?
• Common tax deductions for small businesses
• Common personal tax deductions
• How to claim tax deductions
• Simplify your small business tax preparation with Xero
• FAQs on tax deductions

Key takeaways

• Tax deductions reduce your taxable income, which lowers the amount of tax you owe. They're different from tax credits, which directly reduce your tax bill dollar for dollar.
• You can choose between the standard deduction and itemized deductions each year. The standard deduction for 2025 is $15,750 for single filers and $31,500 for married couples filing jointly.
• Small business owners can deduct expenses like home office costs, business travel, insurance, supplies, and professional services, as long as those expenses are ordinary and necessary for the business.
• Keeping accurate records throughout the year makes it easier to claim every deduction you're entitled to and reduces stress at tax time.

What are tax deductions?

A tax deduction is an expense that you can subtract from your gross income to reduce the amount of income subject to tax. The lower your taxable income, the less tax you owe. Tax deductions are available to both individuals and businesses, and they cover a wide range of expenses from mortgage interest to business operating costs.

The Internal Revenue Service (IRS) generally requires that a business expense be both "ordinary" and "necessary" to qualify as a deduction. An ordinary expense is one that's common and accepted in your industry. A necessary expense is one that's helpful and appropriate for running your business. An expense doesn't have to be essential to qualify; it just needs to serve a clear business purpose.

Here's a simple example of how tax deductions work. Say Jo runs a photographic studio and earns $77,000 in gross income for the year. After adding up all eligible deductions, Jo claims $15,000 in business expenses. That brings Jo's taxable income down to $62,000, which means Jo only pays tax on that lower amount.

How do tax deductions work?

Tax deductions work by reducing the portion of your income that's subject to federal income tax. When you file your tax return, you subtract your eligible deductions from your gross income to arrive at your taxable income. Your tax rate then applies to that reduced amount, resulting in a lower overall tax bill.

The value of a deduction depends on your tax bracket. For example, if you're in the 22% tax bracket, a $1,000 deduction saves you $220 in taxes. If you're in the 32% bracket, that same $1,000 deduction saves you $320. Higher-income earners generally see more dollar-for-dollar savings from deductions.

Tax deductions vs. tax credits

Tax deductions and tax credits both lower your tax bill, but they work in different ways. Understanding the difference helps you plan your tax strategy more effectively.

A tax deduction reduces your taxable income. If you have a $1,000 deduction and you're in the 22% tax bracket, you save $220. A tax credit, on the other hand, directly reduces the amount of tax you owe. A $1,000 tax credit cuts your tax bill by the full $1,000, regardless of your tax bracket.

Tax credits are generally more valuable than deductions of the same dollar amount. Some credits are "refundable," meaning you can receive money back even if the credit exceeds what you owe. Others are "nonrefundable" and can only reduce your tax bill to zero.

Standard deduction vs. itemized deductions

When you file your tax return, you choose between taking the standard deduction or itemizing your deductions. You can't do both, so it's worth understanding which option saves you more money.

The standard deduction is a fixed dollar amount based on your filing status. For the 2025 tax year, the standard deduction amounts are:

• $15,750 for single filers and married individuals filing separately
• $31,500 for married couples filing jointly
• $23,625 for heads of household

For the 2026 tax year, those amounts increase to:

• $16,100 for single filers and married individuals filing separately
• $32,200 for married couples filing jointly
• $24,150 for heads of household

Itemized deductions let you list individual qualifying expenses, such as mortgage interest, charitable donations, and state and local taxes. If your total itemized deductions exceed the standard deduction, itemizing saves you more. Most taxpayers take the standard deduction because it's simpler and often results in a larger deduction.

Common tax deductions for small businesses

If you run a small business, you can deduct many of the costs you incur to keep your business operating. For a detailed look at deductions available to sole proprietors, see the guide to tax deductions for your business. The IRS provides a guide to business expense resources to help US businesses understand deductible business expenses. Here are some of the most common deductions available to small business owners.

Home office deduction

If you use part of your home regularly and exclusively for business, you may qualify for the home office deduction. This applies whether you own or rent your home, and it covers a portion of your housing costs proportional to the space you use for work.

You can calculate this deduction using 1 of 2 methods. The simplified method lets you deduct $5 per square foot of your home office, up to 300 square feet, for a maximum deduction of $1,500. The regular method requires you to calculate the actual expenses of your home office, including rent or mortgage interest, utilities, insurance, and repairs, based on the percentage of your home used for business.

Business travel and vehicle expenses

Travel expenses you incur for business purposes are generally deductible. This includes airfare, hotel stays, meals (at 50% of the cost), and transportation costs when you travel away from your regular place of business.

If you use your vehicle for business, you can deduct those costs using either the standard mileage rate or the actual expense method. For 2025, the IRS standard mileage rate is 70 cents per mile for business use. The actual expense method lets you deduct a percentage of your vehicle's operating costs, including gas, insurance, repairs, and depreciation, based on the share of miles driven for business.

Business insurance

Premiums you pay for insurance that covers your business are typically deductible. Common types of deductible business insurance include general liability insurance, professional liability insurance, commercial property insurance, and business interruption insurance.

Health insurance premiums can also be deductible if you're self-employed. You may be able to deduct the cost of medical, dental, and qualifying long-term care insurance for yourself, your spouse, and your dependents. This deduction is taken as an adjustment to income on your personal tax return, so you don't need to itemize to claim it.

Office supplies and equipment

The cost of supplies and materials you use in your business is deductible. This includes items like paper, ink, postage, software subscriptions, and other everyday office supplies. Even small, one-off purchases can add up; learn more about claiming miscellaneous business expenses.

For larger purchases such as computers, furniture, or machinery, you can often deduct the full cost in the year of purchase under Section 179 of the tax code. For 2025, the Section 179 deduction limit is $2,500,000. Alternatively, you can spread the deduction over several years using depreciation.

Professional services

Fees you pay to accountants, bookkeepers, lawyers, and other professionals for business-related services are deductible. This includes interest on business loans, tax preparation fees for your business return, legal advice related to your business, and consulting services.

If you work with an accountant or bookkeeper who uses Xero, collaboration becomes simpler. You can find a qualified advisor through the Xero advisor directory, which connects you with professionals experienced in small business accounting.

Common personal tax deductions

Beyond business expenses, there are several personal deductions that can reduce your tax bill. These are available whether or not you own a business, though you'll need to itemize your deductions to claim most of them.

Mortgage interest

If you own a home and have a mortgage, you can deduct the interest you pay on loans up to $750,000 (or $375,000 if married filing separately). This is one of the largest deductions available to homeowners and often tips the scale toward itemizing rather than taking the standard deduction.

Student loan interest

You can deduct up to $2,500 in student loan interest paid during the year, even if you don't itemize. This is an "above-the-line" deduction, meaning it reduces your adjusted gross income (AGI) directly. Income limits apply, so higher earners may receive a reduced deduction or none at all.

Charitable contributions

Donations to qualifying charitable organizations are deductible if you itemize. You can generally deduct cash contributions up to 60% of your AGI, though lower limits apply to certain types of property donations and certain organizations. Keep receipts and written acknowledgments for donations of $250 or more.

Medical and dental expenses

You can deduct medical and dental expenses that exceed 7.5% of your AGI. This includes costs for doctors, dentists, surgeons, hospital services, prescription medications, and medical equipment. Expenses reimbursed by insurance don't count toward the deduction.

State and local taxes (SALT)

The state and local tax deduction lets you deduct state and local income taxes (or sales taxes) and property taxes from your federal return. Under the One Big Beautiful Bill Act, the SALT deduction cap increased to $40,000 for 2025 ($20,000 for married individuals filing separately). This higher cap phases down for taxpayers with modified adjusted gross income above $500,000.

How to claim tax deductions

Claiming tax deductions starts with staying organized throughout the year. The more prepared you are, the easier it is to maximize your savings and avoid missing deductions you're entitled to. For a step-by-step approach, check out the small business tax preparation guide.

Keep accurate records

Good record-keeping is the foundation of claiming deductions with confidence. Save receipts, invoices, bank statements, and any documentation that supports your expenses. The IRS recommends keeping tax records for at least 3 years from the date you file your return.

Using accounting software like Xero helps you track expenses as they happen, so you don't have to scramble at tax time. Xero connects to your bank accounts and helps categorize transactions, making it simpler to identify deductible expenses throughout the year. You can also snap photos of receipts and store them digitally, so your records are always organized and accessible.

Work with a tax professional

Tax rules change frequently, and a qualified tax professional can help you identify deductions you might overlook on your own. An accountant or tax advisor who understands your industry can also help you plan ahead for the coming tax year.

If you're looking for an advisor who works with Xero, the Xero advisor directory can help you find a bookkeeper or accountant in your area. Working with a professional who uses the same accounting software you do can streamline the tax preparation process and reduce the chance of errors.

Simplify your small business tax preparation with Xero

Tax deductions can save your business significant money, but only if you track your expenses accurately and claim every deduction you qualify for. Xero's cloud accounting software makes it easier to stay on top of your finances year-round, with automatic bank feeds, expense categorization, and reporting tools designed to simplify tax preparation. Get one month free.

FAQs on tax deductions

Here are some frequently asked questions about tax deductions.

What is a tax write-off?

A tax write-off is another term for a tax deduction. It refers to any expense you can subtract from your taxable income to reduce the amount of tax you owe.

Can you deduct personal expenses?

Most personal expenses aren't deductible. However, certain personal costs, such as mortgage interest, charitable donations, and medical expenses above a specific threshold, qualify as itemized deductions on your federal return.

How do you know which deductions to claim?

Review your expenses for the year and compare them to IRS guidelines for eligible deductions. Working with a tax professional can help you identify deductions you might miss and determine whether to take the standard deduction or itemize.

What happens if you miss a tax deduction?

If you realize you missed a deduction after filing, you can file an amended return using IRS Form 1040-X. You generally have 3 years from the original filing date to amend your return and claim the missed deduction.