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My understanding is that tax deductions "deduct" from the Adjusted Gross Income value. Is that right?

As a very simple example, let's say I have an AGI of $10 and I owe $3 in taxes (before any itemized deductions). If I'm eligible for a deduction of $1, would that dollar subtract from the amount I OWE in taxes? Or would it subtract from the AGI?

I think it would come from AGI, so I would have a new taxable income of $9 and owe $2.7 dollars in taxes.

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    See this answer and the comments thereafter. You don't pay taxes on AGI but on taxable income which is AGI less exemptions less deductions. Your deductions reduce your taxable income and hence the tax due; you don't reduce the tax due dollar for dollar by the amount of your deduction. – Dilip Sarwate Mar 12 '12 at 16:10
  • possible duplicate of Can making a donation reduce your tax bill? – littleadv Mar 12 '12 at 16:56
  • @littleadv - I agree that the answers on this question are probably going to be very close if not identical, but I think this should stay open because it asks the question in a more general way (not specific to donations) and is for that reason the superior version between the dupes. – JohnFx Mar 12 '12 at 19:14
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Think of it this way. The government has determined that certain expenses are effectively offsets of your income.

So you are allowed to subtract things like mortgage interest, property taxes, charitable contributions, etc from your return. To reduce paperwork and provide equity to folks who do not own homes, there is a "standard deduction" that everyone is entitled to.

There are also "tax credits", which are reductions in your tax liability. Credits are often implemented to encourage certain behaviors... for example, if you make energy-saving modifications to your home, you will get a certain amount of money credited to you.

  • Thanks @duffbeer703 So is there any truth to claims from people who say they don't pay anything for federal taxes thanks to Mortgage interest deduction? – Mike B Mar 12 '12 at 18:14
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    @MikeB I am no expert, but I would have to imagine that would be very unlikely to happen. Possibly if you combine it with other deductions, but even then it would be hard. – Kellenjb Mar 12 '12 at 18:43
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    @Mike B - Keep in mind that there are a lot of people who incorrectly assume that they don't pay any taxes just because they don't have to write a check on April 15th. – JohnFx Mar 12 '12 at 19:10
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    @MikeB - absolutely. From Duff's list there are quite a few things that add up for Sch A deductions. A couple can easily wipe out the income that remains after their 4 exemptions for themselves and the kids and with a bit of mental accounting feel that it's the mortgage interest that was the last $5K to wipe out their taxable income. Keep in mind, families of 4 grossing under $50K may very well pay zero tax. I wrote joetaxpayer.com/who-pays-no-tax in 2011, example is $56K for a couple. Zero Tax. – JTP - Apologise to Monica Mar 13 '12 at 3:11
  • @JohnFx: Also worth noting that half of Americans really don't pay any taxes. (See, for example, JoeTaxpayer's article above for a fully worked example, or this article for the broader picture.) – bstpierre Mar 14 '12 at 21:10

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