Every year, tax time shows up like a bad penny.
Speaking of pennies, if you want to save some of your pennies, it’s important to understand what tax credits and tax deductions are and how they differ.
Both tax deductions and tax credits can help reduce the amount of tax you pay, but they work in different ways. Tax credits provide a dollar-for-dollar reduction on your tax bill, and are worth more than deductions but just as much. Tax deductions reduce your taxable income.
Let’s look at pre-tax deductions
You have probably heard of a tax deduction. But what is it exactly?
A pre-tax deduction is an amount of money subtracted from your income before calculating how much you owe. Reduce the amount of income you pay taxes on, so you can pay less tax. How much a deduction saves you depends on your income tax category.
When you do your taxes, you can choose to take an itemized deduction or a standard deduction. Of course, you should choose the one that saves you money.
Itemized deductions include things like:
- Student loan interest
- Medical and dental expenses
- State and local income tax
- property taxes
For example, if you own a home and pay $2,500 in property taxes, you may be able to deduct it from your income.
If you don’t have things that can be itemized, or a standard deduction saves you more money, that’s the way to go. The standard deductions for 2019 are $24,400 for married filing jointly, $18,350 for those filing as head of household, and $12,200 for single and married filing separately.
Tax credits
While tax deductions come from your income, tax credits take dollars off your final tax bill.
It’s a dollar-for-dollar reduction in the amount of tax you owe.
Let’s say you owe $5,000 in taxes and you qualify for a $1,000 tax credit of some kind: that tax credit will reduce what you owe in taxes from $5,000 down to $4,000.
There are federal, state, and even local tax credit programs for everything from raising children to restoring historic properties.
Other common tax credits may include:
- Work income tax
- Lifetime Learning Credit
- Saver’s Tax Credit
- child tax credit
- Energy-Efficient Residential Property Credit
So what is the basic difference in how a tax deduction and a tax credit work?
The big difference between tax credits and tax deductions is this: Tax credits directly reduce the amount of tax you owe in the first place.
Tax deductions reduce the income you pay taxes on, so you owe less.
The bottom line
Taxes are confusing —Most of us don’t understand them, much less know how to complete them!
How do you do the right things to recover the maximum amount from the government? How do you pay as little as possible? What exactly are tax loopholes, and is that the only way to save money on taxes? If it makes you feel better, you’re not the only one asking these questions.
So, there you go. That wasn’t so bad. Instead of struggling with your taxes this tax season, because let’s face it, most of us have no idea how to file perfectly, so why not leave it to the experts to help you get the refund you deserve and do not pay more on your part.
