A tax credit is a dollar-for-dollar reduction of your tax liability, meaning if you owe $1000 in taxes and you have a $200 tax credit, your tax liability is reduced to $800. Some credits are non-refundable, meaning that the credit can only offset taxes owed, but if the credit exceeds the taxes owed, the taxpayer won't receive a refund. Some credits are partially refundable or refundable, meaning that the credit will offset taxes owed and any remaining credit will be refunded to the taxpayer.
On the other hand, tax deductions reduce the amount of your income subject to taxes. Deductions are expenses that a taxpayer can subtract from their taxable income, which reduce the overall amount of income that is subject to taxes. Tax deductions can be either "above the line" or "below the line." Above-the-line deductions are subtracted from income before determining adjusted gross income (AGI) and can be taken regardless of whether the taxpayer itemizes their deductions or takes the standard deduction. Examples of above-the-line deductions include contributions to a traditional IRA and self-employment taxes. Below-the-line deductions are subtracted from AGI and are only available to taxpayers who itemize their deductions. Examples of below-the-line deductions include mortgage interest, state and local taxes, and charitable donations.
Here's an example of how a tax deduction affects your taxable income. If you have a $1000 tax deduction and you are in the 24% tax bracket, your taxable income is reduced by $240 (24% of $1000) and therefore your tax liability is reduced by $240. Stated another way, your taxable income is calculated based on all your income less all your deductions.
Whether a tax credit or tax deduction is better for a taxpayer depends on their individual tax situation. Each credit and deduction have different rules, limits, and restrictions and it's important to consider the specific credit or deduction and the taxpayer's eligibility for it, to determine which one will provide the biggest tax benefit.
Generally stated, a tax credit will give you much more of a tax benefit than a tax deduction. Don't discount possible tax deductions though. They can still be very beneficial.
Some examples of tax credits include:
Child Tax Credit: This credit is worth up to $2,000 per child under age 17 and is partially refundable, meaning that even if the credit exceeds the amount of taxes owed, the taxpayer will receive a refund for a portion of the credit.
American Opportunity Tax Credit: This credit is worth up to $2,500 per student for the first four years of post-secondary education and can be claimed for qualified expenses such as tuition, fees, and course materials.
Lifetime Learning Credit: This credit is worth up to $2,000 per tax return, regardless of the number of students in the household, and can be claimed for qualified expenses such as tuition and fees for undergraduate, graduate, and professional degree courses.
Child and Dependent Care Credit: This credit can provide a credit of up to $3,000 for one qualifying individual and $6,000 for two or more, it's for expenses paid for the care of a qualifying child under age 13 or a dependent or spouse unable to care for themselves, so the taxpayer can work or look for work.
It's worth noting that the eligibility, maximum credit amount, and other rules for these credits can change from year to year, so it's important to check the IRS website or consult with your local Herriman tax accountant for the most up-to-date information.
Some examples of "above-the-line" tax deductions include:
Retirement Savings Contributions: Taxpayers can claim a deduction for contributions made to a traditional IRA, subject to income limits and phase-out rules.
Business Expenses: Self-employed individuals can claim deductions for expenses related to their business, such as office supplies, equipment, and other business expenses.
Education Expenses: Taxpayers may be able to claim deductions for certain education expenses, such as tuition and fees, for themselves or a dependent.
Moving Expenses: Taxpayers who move for a new job may be able to claim deductions for certain moving expenses, such as the cost of transportation and storage of household goods.
Some examples of "below-the-line" tax deductions for those that itemize may include the following:
State and Local Taxes (SALT): Taxpayers who itemize can deduct state and local income, sales, and property taxes, subject to a combined limit of $10,000 for the tax year 2022.
Mortgage Interest: Taxpayers who itemize their deductions can deduct the interest paid on a mortgage for their primary residence, subject to limits based on the date of the mortgage and the amount borrowed.
Charitable Contributions: Taxpayers who itemize their deductions can deduct donations made to qualified charitable organizations, subject to limits based on the type of organization and the taxpayer's adjusted gross income.
Medical and Dental Expenses: Taxpayers who itemize their deductions can deduct out-of-pocket medical and dental expenses that exceed 7.5% of their adjusted gross income.
Please note, tax laws are subject to change and these deductions may not apply or may have certain restrictions and limits, it's always best to consult with your Herriman tax accountant or check with the IRS for the most up-to-date information.
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