One of the foremost aspect of tax credit vs. tax deduction debate is to comprehend the obvious differences between the two. Once these differences are crystal clear, only then you will be able to evaluate which concept is more preferable. Keep in mind that the differences between the two opposing concepts can be articulated through the manner your taxes are affected.
The common ground in the tax credit vs. tax deduction debate
Keep in mind that whatever you choose, tax credit or tax deduction, both will help you to cut down your income tax responsibility. For this reason, countless number of people each year depend on tax deductions or tax credit in order to save money for future. However, as you try to use both aspects of tax to your advantage, it should be noted that both are different from one another.
Differences on the periphery
At a surface level, the differences between the two concepts are very obvious. As far as tax credits are concerned, they aim to provide a dollar for dollar saving in the accountability of your income tax. It means that $1000 with tax credit will allow you to save $1000 in taxes. However, the tax deduction aspect of US tax tends to reduce your that income that is supposed to be taxed. In this way, the taxable income matches with the percentage of your marginal tax range.
Which is better
As mentioned earlier, while both of the tax deduction and tax credit helps you to do savings for the future, yet it is always preferable that you choose tax credit. It is because tax credit is much more valuable than tax deduction that it takes in to consideration the dollar-equivalent concept and is measured through the use of percentages. So, let us understand these two concepts through numerical. For example, a $1000 worth tax credit will help you to save $1000 in taxes, while tax deduction will be calculated against the marginal taxation bracket. So, if the marginal tax bracket is 25%, a $1000 tax deduction will help you to save $250.
See let us now see both the concepts in greater detail.
Tax deduction
Tax deduction will help you to reduce your income that is taxed. In this respect, tax deductions always take place before the final income is calculated.
Tax deductions are categorized in to two sections namely, the itemized deductions and standard deductions. So, a taxpayer must use one of them at a time, not both of them. Moreover, it is commonly advisable that you use itemized tax deductions if the gross total is much higher as compared to the standard deductions.
How do you arrive at your adjusted Gross income (AGI)? The AGI is the income that is the calculated after you subtract the tax deductions. So once you subtract the tax deductions from your total income you ultimately figure out your AGI.
In a nutshell, the tax deductions allows you to lower down the amount of money upon which you have to pay taxes.
Tax credit
So, once you have calculated the amount of the tax that is to be levied upon your income, you use this figure to decipher how much you need to pay for the taxes.
On the tax table, you can clearly see your income and this will simultaneously give you the idea regarding the amount you are indebted to pay. Once you get to know how much you are indebted to pay for the levied taxes, you can easily subtract the figure you have previously paid. The subtracted money includes the amount in remission from your pay check and the amount of money that you have paid in trimestral taxes.
So, the figure you arrive at after the subtracting the money you owe in taxes, in that figure, you add in the tax credits. In this respect, the tax credit gets and upper hand over tax deductions because it directly decreases the amount of money you are indebted to pay in your taxes.
Therefore, in the tax credit vs. tax deductions debate, tax credits outsmarts its opponent. While tax credit directly help you to save dollars, tax deductions merely lowers the sum of money upon which your taxes are based on.
