Tax Credits and Deductions – What is the difference and how do you claim them on your tax return? The Internal Revenue Service requires everyone with an earned income of at least $12,400 to file a federal income tax return. If you worked during the tax year but didn’t earn this much, you are exempt from filing a tax return. But this isn’t the case for most adults as they are required to file a tax return.

One of the staples of the US tax code is the deductions and the credits. Both are used for helping you pay less tax but in different ways.

Tax Deductions – Explained

The deductions work by reducing the portion of your income you will be taxed. For example, if your adjusted gross income is $50,000 and the deductions you’re eligible to claim on Schedule A is $15,000, you will be taxed at $35,000, not $50,000.

The deductions can be placed in two different categories: the standard deduction and itemized deductions. When filing a federal income tax return, you must pick either one of the deductions. If you take the standard deduction on the tax return which is $12,550 for singles and $25,550 for joint filers, you won’t be able to itemize, and vice versa.

Having said that, make up your mind by figuring out the itemized deductions you can take on Schedule A and if it exceeds the standard deduction, itemize. If not, don’t itemize.

Tax Credits – Explained

The tax credits work differently than tax deductions. They work by reducing the amount owed to the IRS so are much more valuable than deductions in comparison. For example, if you owe $4,000 to the IRS and the credits you’re eligible to claim on your tax return is $3,000, you will owe $1,000 to the IRS. They bring in more value than any other deduction out there and perhaps the standard deduction is accounted for it as well in most occasions.

Same as the deductions, the tax credits can be put in two different categories. Some tax credits are refundable whereas some aren’t. A refundable tax credit will add to your tax refund. While some refundable tax credits add the total value of it to your tax refund, some will only add up a portion of the credit amount. One of the most commonly claimed tax credit – the child tax credit – has a value of up to $2,000. Out of the two grand you get, as much as $1,400 of it is refundable, meaning it can add up to your refund.

You may also like

Leave a Reply