What is defined as an expense that reduces taxable income?

A tax deduction is defined as an expense that reduces taxable income. This means that when an individual or business has deductible expenses, those amounts can be subtracted from their total income before calculating the tax owed, thereby lowering the overall tax liability. Common examples of tax deductions include expenses related to business operations, mortgage interest, and charitable contributions.

The importance of tax deductions lies in their ability to alleviate some of the income subject to taxation, ultimately leading to potentially significant tax savings for taxpayers. It's a critical concept in tax law that encourages certain behaviors, such as charitable giving or investment in business activities.

Tax credits, on the other hand, directly reduce the amount of tax owed on a dollar-for-dollar basis rather than adjusting taxable income. This makes them a different financial mechanism in terms of tax benefits. Capital gains refer to the profit from the sale of an asset, which is subject to taxation if the asset is sold for more than its purchase price. Exemptions allow for a certain amount of income to be excluded from taxation, but they do not function the same way as deductions, which specifically reduce the taxable income amount.