Part I · Compliance — How the System Operates · pp. 33–48

Chapter 3: Deductions — Reducing the Tax Base

Deductions reduce taxable income only where Congress has specifically authorized the subtraction, and each one must trace to a Code provision, satisfy its requirements, be properly positioned above or below the line, and be substantiated.

Overview

This chapter explains how deductions reduce the amount of income subject to federal tax. It covers the foundational principle that deductions exist only through legislative grace—meaning taxpayers must point to specific statutory authority for every deduction claimed. The chapter walks through the distinction between above-the-line deductions (which reduce adjusted gross income) and below-the-line deductions (which reduce taxable income), and why that distinction matters for thresholds, phase-outs, and eligibility for other tax benefits.

The chapter then surveys the major deduction categories in detail: above-the-line deductions under Section 62, the standard deduction versus itemized deductions, new temporary OBBBA deductions for tips, overtime, seniors, and car loan interest, business deductions under Section 162, expensing and bonus depreciation under Sections 179 and 168(k), the Qualified Business Income deduction under Section 199A, and the various limitations and substantiation rules that govern all deductions.

In this chapter

• 3.1 The Nature of Deductions — Deductions reduce the tax base and exist only by legislative grace, with the taxpayer bearing the burden of proving entitlement
• 3.2 Above-the-Line vs. Below-the-Line — The distinction hinges on whether a deduction reduces AGI, which in turn affects eligibility for numerous tax provisions
• 3.3 Above-the-Line Deductions — Section 62 deductions subtracted from gross income to arrive at AGI, available regardless of itemizing
• 3.4 Below-the-Line Deductions — Itemized vs. Standard — Taxpayers choose between the standard deduction and itemized deductions, whichever is greater
• 3.5 New OBBBA Deductions — Tips, Overtime, Senior, and Car Loan Interest — Four temporary above-the-line deductions set to expire after 2028
• 3.6 Business Deductions Under Section 162 — The foundational business-expense statute requires expenses to be ordinary, necessary, paid or incurred, and in carrying on a trade or business
• 3.7 Section 179 and Bonus Depreciation — Two mechanisms for immediately expensing the cost of qualifying business property
• 3.8 QBI Deduction — Section 199A — A deduction of up to 20 percent of qualified business income from pass-through entities, subject to SSTB and wage/property limitations for higher-income taxpayers
• 3.9 Limitations and Disallowances — Multiple Code provisions restrict or deny deductions for capital expenditures, entertainment, hobby losses, passive losses, at-risk amounts, and related-party transactions
• 3.10 Substantiation Requirements — Every deduction requires documentation of amount, date, purpose, and payee, with heightened rules for travel, meals, listed property, and charitable contributions
• 3.11 Conclusion — Every deduction needs statutory authority, satisfied requirements, substantiation, and correct positioning above or below the line

Key terms

• Legislative grace — The principle that deductions exist only because Congress has authorized them, and the taxpayer must prove entitlement
• Above-the-line deduction — A deduction subtracted from gross income to arrive at AGI, reducing both taxable income and AGI for threshold purposes
• Below-the-line deduction — A deduction subtracted from AGI to arrive at taxable income, consisting of either itemized deductions or the standard deduction
• Standard deduction — A fixed amount by filing status that reduces taxable income, chosen when it exceeds total itemized deductions
• Ordinary and necessary expense — The Section 162 standard requiring that a business expense be common and accepted in the trade or business and appropriate and helpful to it
• Qualified business income (QBI) — The net amount of qualified income, gain, deduction, and loss from an active pass-through trade or business, excluding capital gains, W-2 wages, and certain other items
• SSTB (specified service trade or business) — A service-based business in fields like health, law, consulting, or accounting whose QBI deduction phases out entirely above certain income levels
• Substantiation — Documentation sufficient to establish that an expense was incurred, qualifies for deduction, and is accurately stated in amount

Who needs this chapter

This chapter serves practitioners and taxpayers who need to understand what expenses the Code allows as deductions, where they fall relative to AGI, what limitations apply, and what records must support them.