How Deductions Work

• A tax deduction is an expense that the IRS allows you to subtract from your taxable income. In other words, a tax deduction reduces your total taxable income instead of reducing the amount of tax you owe. For example, if your annual income was $50,000 and you have $10,000 worth of tax deductions, your taxable income is reduced to $40,000.
  
  

Tax Rates After Deductions

• The amount of income tax owed to the IRS is determined by tax brackets that apply to your income after you take out tax deductions. Tax brackets are different depending on your tax filing status, so the percentage of income you pay after deductions depends on whether you file as a single person, a head of a household, a married person filing jointly or a married person filing separately. According to Banrkate, for single filers in 2011, the first $8,500 of income is taxed at 10 percent, income between $8,501 to $34,500 is taxed at 15 percent, income between $34,501 to $83,600 is taxed at 25 percent, income between $83,601 and $174,400 is taxed at 28 percent, income between $174,401 and $379,150 is taxed at 33 percent and income in excess of $379,150 is taxed at 35 percent.
  
  

Potential

• Tax deductions could potentially drop you into a lower income tax bracket and reduce the highest tax rate you face. For example, if you earn $40,000 in 2011, the income in excess of $34,500 is taxed at 25 percent. If, however, you take $10,000 worth of tax deductions, your taxable income would fall to $30,000. At this income level your highest tax rate would be 15 percent instead of 25 percent.
  
  

Considerations

• Tax credits are another type of tax break that reduce the taxes you owe. Unlike deductions, tax credits, which directly reduce your tax liability, are applied after you calculate the amount of tax you owe. . For example, if you owe $5,000 in income taxes after deductions but you have a tax credit of $1,000, the amount of tax you owe falls to $4,000.