The Difference Between Tax Credits and Tax Deductions
When it comes to taxes, everyone has the same goal – to save as much money as possible. Fortunately, there are many possible ways to do this. Two very common and effective ways to save money on your tax return include utilizing tax credits and tax deductions. Tax credits and tax deductions have one thing in common. Both save you money when tax time comes. But the way they do this is very different. It is important to understand how these two mechanisms work so you can maximize your savings and keep as much money as possible in your pocket this year.
What Are Tax Credits?
If you are eligible for a tax credit, you subtract the amount of the tax credit – dollar for dollar – from what you owe in taxes. This is an excellent way to keep money in your pocket. So, if you qualify for a tax credit, USE IT! A child tax credit will give you a full $1,000 of credit to put against any taxes you owe that year. So, if you do your taxes without taking advantage of the child tax credit and owe $1,500 to the IRS, you will only owe $500 once you take advantage of the credit. Other common examples of tax credits are the earned income tax credit, the American Opportunity Tax Credit and child and dependent care credits.
What Are Tax Deductions?
Unlike a tax credit, which reduces your tax liabilities, tax deductions are qualifying expenses that reduce your taxable income. Tax deductions can either come in the form of standardized deductions or itemized deductions. Standardized deductions are set by the IRS and do not require you to save receipts or keep back-up documentation. This is quick and easy, but may not save you the most money. If you take the time to itemize your deductions using Schedule A, you can deduct all things that apply to your financial situation like mortgage interest, medical expenses, retirement contributions, home office expenses, state income taxes, charitable donations and much more. Just keep in mind that you can take advantage of the scenario (standard or itemized) that benefits you most.
Translating This to Your Tax Return
If you compare tax credits to tax deductions, tax credits give you a more direct savings because you are able to subtract the full credit amount from what you owe in taxes. The key is to use all tax credits you are eligible for in a given tax year AND choose the deduction (standard or itemized) that benefits you the most. Used together, these two strategies can save you hundreds, even thousands of dollars on your upcoming tax return.
If you have questions about what tax credits you might be eligible for or what types of expenses you can deduct this year, you might consider getting some outside advice before you submit your tax return. Success Tax Relief has been helping people just like you all over the country submit accurate tax returns while keeping the most money in your pocket. We can review all of your documents and make concrete recommendations that are individualized just for you. Contact us today for a free consultation!