General Limitations

• Normally, expense deductions are limited to "reasonable and necessary" expenses. This is a subjective standard that could cause a dispute in the event of an IRS audit. If a particular deduction is limited to business expenses, it must have been incurred for a business purpose. If you mix business and pleasure -- for example, if you take a business trip and stop by a tourist attraction on the way home -- you must reduce the amount of your deduction by the amount that was spent for non-business purposes.
  
  

"Above the Line" vs. "Below the Line" Deductions

• An "above the line" deduction, such as alimony, is subtracted from your gross income to arrive at your adjusted gross income. A "below the line" deduction, such as business travel expenses, is subtracted from your adjusted gross income to arrive at your taxable income. The significance of this is that you may use an "above the line" deduction together with the standard deduction ($3,650 for most taxpayers as of the date of publication), while you must sacrifice the standard deduction to take a "below the line" deduction.
  
  

Deductions vs. Credits

• A tax deduction is subtracted from your taxable income, while a tax credit is subtracted from your total tax due. For this reason, a credit is likely to save you more than a deduction will. For example, if your taxable income is $100,000, a $4,000 tax deduction will reduce it to $96,000. If your tax rate is 25 percent, this will save you $1,000 by reducing your total tax due from $25,000 to $24,000. A $4,000 tax credit, by contrast, will reduce your total tax due from $25,000 to $21,000.
  
  

Penalties

• You are responsible for any errors on your tax return, even honest ones. If you take an unwarranted deduction or credit, the IRS will impose late penalties if you fail to discover your error by the time your tax return is due. The penalty for late payment of taxes is 0.5 percent of the overdue amount per month, plus 4 percent interest (as of the date of publication). The IRS also imposes more serious financial penalties if it concludes that you acted negligently or frivolously. If your error was intentional, the IRS might seek prosecution for tax evasion.