It’s common knowledge that tax credits and tax deductions can both help lessen your overall income tax liability. You may be one among millions of taxpayers searching for credits and deductions every year in order to save money. It’s normal to want to take advantage of as many of these as possible but there are differences between tax credits and deductions you may have overlooked that needs to be reviewed before you file your tax return.
Basic Differences
A dollar-for-dollar reduction of your income tax liability is provided by tax credits which means if you have a $1,000 tax credit, you get to save $1,000 in taxes. Tax deductions, on the other hand, lower your taxable income and are equal to the percentage of your marginal tax bracket. A tax credit is always worth more than a dollar-equivalent tax deduction since percentages are used to calculate the deductions.
Tax Credit & Tax Deductions: A Closer Look
You may get a reduced liability dollar-for-dollar with tax credits but they will not reduce your income tax liability to less than zero. To put it simply, the amount you’re responsible to be before any credits are applied is your gross income tax liability.
Majority of tax credits are non-refundable and with that said, any excess amount expires in the year in which it was utilized. This means the additional amount will be not be given back to you. However, there are some refundable tax credits you can use to help you grow your tax refund.
You first need to know what is available to taxpayers in your situation before you get a better of how tax credits work and whether or not you qualify. These include your filing status, age, employment, and education. Remember, you don’t always qualify for all other tax credit just because you qualify for one type of tax credit.
The worth of your tax credit depends on the type of tax credit you qualify for. The amount of tax credit is different as well as the qualification guidelines. It’s important that you are 100% accurate with the information involved in that type of credit as it reduces the amount of money you pay in income tax. A tax professional can help you double check whether or not you qualify for a tax credit before you claim it on your income tax return.
Tax Credits may be less common than tax deductions but you can take advantage of them when adopting a child, buying your first home, childcare experience, home office expenses, and caring for your elderly parent. Various business tax credits are also available.
Tax deductions on the other hand, as mentioned earlier, reduce your taxable income and the percentage of your marginal tax bracket will be used to calculate them. Here’s a simple example: If you are in the 25% tax bracket, a $1,000 tax deduction will allow you to save $250 in tax (0.25 x $1,000 = $250).
The 2 main types of tax deductions are the standard deduction and itemized deductions. Every taxpayer is only allowed to use one type of deduction, not both. Generally, you will be advised to do an itemize deductions if their total is higher than the standard deduction. They are easy to understand and calculate but if you want to take an even closer look, you may consult a tax professional who is an expert on this matter.
The Conclusion
There’s really no better option between a tax credit and tax deduction. Your situation and the kind of tax savings you qualify for will decide which between the two is best for you. It is, however, a fact that both tax credits and tax deductions over several benefits; only different ways to reduce the amount of tax you need to pay to the IRS. The main difference the two: tax deductions are taken from your gross income while tax credits are taken directly from the amount you owe.
Overall, you can pay a lesser income tax regardless if you choose tax credits or the deductions. Make it a goal to take full advantage of every tax credit and deduction that you qualify for and as long as your eligible, you should be able to claim the tax credit/deduction before reporting it on your income tax return. Furthermore, a misinformation on your tax return may lead to an IRS tax audit so carefully enter all your information in your file.
