What is the Difference?
Filing taxes can be a source of stress and a challenge for many. What is the difference in Tax Credits vs. Tax Deductions? No one wants to pay more than they owe, and if there’s a way to save money, why wouldn’t you take it? But do you know what kinds of tax reductions are available and how to claim them on this year’s tax form? Today, we’ll discuss the differences between two common tax reductions: credits and deductions. Both have their merits and the ability to reduce the amount you’ll pay in taxes. But, if you decide to claim a credit or deduction on your taxes, which should you take? Let’s discuss how each works.
How Do Tax Credits Work?
Tax credits are a dollar-for-dollar reduction of your tax liability (the amount owed) and are based on several factors; age, income, and financial responsibility. This reduction is done by decreasing the amount of taxable income and not the actual amount of tax. For example, if you were to owe $2,000 in taxes but applied for a $500 tax credit, the new taxes owed would be $1,500. They may or may not be considered refundable, or partially refundable, depending on the type of tax credit you are applying for. In other words, some reductions may offer a larger tax refund, while others will simply reduce the tax liability to zero. It is important to note that tax credits can only be applied once.
How Do Tax Deductions Work?
Tax deductions, on the other hand, are a dollar-for-dollar reduction on your taxable income for the year. By lowering the amount of income that will be taxed, you may potentially pay less tax. Typically, this comes in the form of two different kinds of deductions: standardized and itemized. Standardized tax deductions come in the form of fixed rates depending on filing status. The largest of these standardized tax deductions is for married couples filing jointly.
Itemized tax deductions are deductions for individual expenses listed out and written off on your tax form. These deductions include expenses like charity donations, student loans, medical and dental expenses, moving expenses to start new jobs, work travel, mortgage interest, and contributions to a traditional IRA and Health Savings Accounts (HSA). It is important to note that certain itemized tax deductions may be restricted by your filing status. Talk with your tax specialist for a full list of itemized deductions you can claim on your 2024 taxes.
Tax Credits vs. Tax Deductions: Which Do I Choose?
There is no right answer! Each scenario is unique to the filer. There is no one-size-fits-all tax deduction or tax credit. Both will reduce the total amount you will pay in taxes, either by reducing the amount owed or your total taxable income. If you want to learn more about how to reduce your taxes this year, schedule a free consultation with a DCG tax consultant today!
