Tax Deduction vs Tax Credit: More Savings
What is a tax deduction? A tax deduction is an allowable expense that is used to lower your taxable income. The most common deduction for individuals is the standard deduction. The amount of the standard deduction varies every year. For tax year 2021 the standard deduction is $12,550 for single taxpayers and $25,100 for married taxpayers filing jointly.
For tax payers with higher allowable expenses, they can chose to itemize their deductions. Taxpayers who itemize their deductions cannot claim the standard deduction. They instead keep track of their allowable expenses dollar for dollar. They are then reported on Schedule A of the tax return. Itemizers do need to consider the deductibility of their expenses. Some allowable expenses are limited or not 100% deductible. Consult your tax prepared on the specific considerations for your taxable situation. Some examples of allowable deductions are:
- – Medical and dental
- – State and local income or sales taxes
- – Property taxes
- – Mortgage interest
- – Personal property taxes
- – Interest on certain investments
- – Student loan interest
- – Charitable contributions
- – Traditional IRA contributions
- – HSA contributions
- – Union dues
- – Tax preparation fees
- – Self employed business expenses
Deductions are subtracted from a taxpayers taxable income. For example, if a taxpayer starts with $50,000 of taxable income, and has $20,000 of allowable deductions, they are now only paying tax on $30,000 worth of income. This can be a significant tax savings for taxpayers.
What is a tax credit? Tax credits are amounts allowed at the state or federal level that lower the taxes you owe. Each credit allowed is for different amounts and taxpayers must meet a certain criteria in order to claim each one. Tax credits tend to be incentives to taxpayers to do certain things during the year (i.e. tax credits for putting solar panels on your house, or adopting a child).
The requirements to claim a tax credit differ based on the credit and the taxpayers taxable situation. Consult your tax preparer on the types of credits available for your taxable situation. Some examples of common tax credits are:
- – Earned Income Tax Credit
- – Child Tax Credit
- – Other Dependent Credit
- – Child and Dependent Care Credit
- – American Opportunity Tax Credit
- – Lifetime Learning Credit
- – Savers Tax Credit
- – Adoption Credit
- – Residential Energy Credit
Tax credits are subtracted directly from the taxpayers tax liability (taxes owed). For example if a taxpayer starts with a $5,000 tax liability, and qualifies for a $2,000 tax credit, their new tax liability is $3,000. Credits can be a more significant savings for taxpayers. Some tax credits are fully refundable, some are partially refundable, and some are nonrefundable. A refundable tax credit means if your tax liability is zero, the amount of the credit, in this example $2,000, would be refunded directly to the taxpayer.