Tax Credit and Deduction: Key Differences

Tax Credit and Deduction: Key Differences

Tax Credit and Deductions: Which is More Important

No one wants to pay more to the IRS in taxes than they have to. Thankfully, the United States tax law is set up with many opportunities for individuals and businesses to lower their tax burden via valid measures.

When people think of taxes, tax credits and deductions are the first to come to mind, as both are aspects of tax law that reduce how much tax one pays each year. However, many people conflate these two and don’t recognize that they are by definition separate things. While both tax deductions and tax credits, when properly taken, reduce your final tax bill, they are implemented in different situations and benefit you as a taxpayer in unique ways.

Tax Credits

When calculating the amount of taxes you owe at the end of the year, a tax credit can be your best friend because it directly reduces the amount of taxes you owe. A few of the most common tax credits are the child tax credit (good for $2,000 per child), the lifetime learning credit (worth 20% of the first $10,000 you pay towards tuition or fees up to $2,000), and the residential energy credit (equal to up to 26% of the cost to install solar power equipment in your home). Tax credits are very beneficial because they directly reduce the amount of tax you pay (or increase the amount of tax return you’ll receive) by the direct amount. For instance, if a family is set to pay $10,000 in taxes, they can add the child tax credit for one child in their household. This will leave the family only having to pay $8,000 in taxes.

Tax Deductions

Tax deductions are quite common, including deductions for charitable donations, a 401(k) or IRA retirement contributions, for home office purchases, and for medical expenses that are more than 7.5% of your adjusted gross income. When implemented accurately and correctly, each of these deductions will reduce your taxable income and lower the amount of your ultimate tax bill. However, it’s important to remember that tax deductions do not reduce the tax liability in a direct dollar amount like credits do.

Importance of Keeping Credits and Deductions Straight

Tax deductions and tax credits are critical to remember when preparing your annual taxes, as you don’t want to pay more than you’re obligated. But it’s important not to treat credits and deductions as the same since their impact, documentation, and implementation differ.

Due to the tax law changes every year, new credits and deductions may pop up while existing ones are removed. If you want to ensure you don’t overlook tax credits or tax deductions owed to you, it’s best to seek tax financial assistance from Tobin & Collins. Contact us to start your financial journey today!

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