What is a tax deduction?
Tax deductions (definition)
A tax deduction is a business expense that can lower the amount of tax you have to pay. It’s deducted from your gross income to arrive at your taxable income. It is sometimes called a tax write-off.
Tax deductions can include business expenses like office rent, equipment, business insurance and business travel. You can usually fully or partly deduct most business expenses. Your tax authority will have details of the specific expenses, and the circumstances in which you can deduct them.
Example of a tax deduction calculation
Jo owns a photographic studio. She made $77,000 last year and has $15,000 of expenses she can deduct. That means her taxable income for the year is $62,000.
To be a legal tax deduction, an expense must have a legitimate purpose within your business. This means buying a camera is a legitimate business expense for a photographer – but probably not for a baker.
You can’t deduct personal expenses, like groceries. But if an expense is partly personal and partly business, you can generally claim the business component. If you buy a new cell phone and use it for business 80% of the time, you may be allowed to deduct 80% of that cost.
Keep receipts of all your expenses, no matter what you’re deducting. Keeping proof of your expenses will keep you out of trouble if IRD audits you.
Tax deductions can save you heaps of money – but they can be complicated. Tax laws can change annually, so it’s worth checking with an accountant or tax agent to understand your specific situation and make sure you’re claiming the right things.
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This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.