What is the difference between a tax deduction and a tax deferral?


by lucienne , in category: Taxation and Accounting , a year ago

What is the difference between a tax deduction and a tax deferral?

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1 answer

by london_lueilwitz , a year ago


A tax deduction and a tax deferral are both strategies used to reduce taxable income, but they differ in terms of timing and eventual tax consequences.

  1. Tax Deduction: A tax deduction allows taxpayers to subtract specific expenses or amounts from their total taxable income, thereby reducing the amount of income subject to tax. Deductions are generally taken in the year the expense is incurred, resulting in an immediate reduction in taxable income and consequent tax liability. Common deductions include mortgage interest, charitable contributions, medical expenses, and business expenses.
  2. Tax Deferral: Tax deferral refers to the postponement of tax liability to a future period rather than the present. It involves reducing current taxable income by deferring the recognition of income or gains to a later year. This can be done by utilizing various investment or retirement savings vehicles, such as a traditional Individual Retirement Account (IRA), 401(k), or deferred compensation plans. The advantage of tax deferral is that it allows individuals or businesses to defer paying taxes on income or gains until a later time when their tax rates may be lower.

In summary, a tax deduction reduces the taxable income for a particular tax year, resulting in a lower tax liability for that year. Whereas, a tax deferral allows taxpayers to delay the payment of taxes on income or gains to a later year, potentially taking advantage of lower tax rates in the future.