Tax deductions and tax credits are similar, but they are not the same thing. As we approach tax season, it is good to know the difference when you go into the accountant’s office. While most accountants will help you figure these things out when you come into the office, you will want to have a good idea about what these things are.
Tax deductions reduce the amount of taxable income that you can claim at the end of the year. For example, you can deduct the interest that you pay on your mortgage from your taxable income each year. If you make $40,000 a year, and you pay $2000 in interest on your mortgage, then you can claim $38,000 in income. This in turn reduces the amount of taxes that you have to pay because it reduces the amount of income that you claim. This is called the Mortgage Interest Deduction, and it is only one example of a tax deduction.
Tax credits are similar, but they reduce the amount of taxes that you owe without affecting the amount of taxable income that you can claim. For example, the Hope tax credit is designed to help people pursuing an education. With this tax credit you can reduce your taxes by up to $1800 when you claim that amount of educational expenses. You have another tax credit that you can claim if you have dependent children, and up until 2010 there was a first time homeowner’s tax credit.
Some tax credits are considered refundable tax credits. This means that if you can claim a tax credit that is higher than the taxes that you owe, you will receive the difference as a tax refund.
Some people think that tax credits are the better of the two because they directly reduce the amount of tax that you have to pay, but both credits and deductions can be very helpful in reducing the amount of taxes that you owe. For tax credits and tax deductions, it is important to know which ones that you can claim each year.
Fortunately, many accountants will ask you specific questions and go through your financial records to see which deductions or credits you can receive. However, before you go into the accountant’s office, you should take some time to look for credits or deductions you might be able to claim.
If you have a house, a child or even energy efficient appliances, you might be able to receive a tax credit. Many people contribute part of their income to a retirement account of some sort, such as a Roth IRA. You can receive a tax credit for up to 50% of the money that you contribute to these accounts. This tax credit is not a refundable tax credit. In addition to these tax credits, you can often find tax credits that are designed to help businesses, especially small ones.
When it comes to tax deductions there are many that apply to specific situations. This means that many of these deductions might not apply to you, but many of them might. For example, if you have made any charitable contributions during the year, you can deduct that donation from your taxes.
Even if you contributed canned goods to a food drive, you can deduct that cost from your taxes. You can get a deduction if you pay for childcare, if you help your children pay student loans, if you spent money searching for a job, or if you traveled on business (generally just the self-employed).
It is partially your responsibility to research what deductions and credits apply to you, though a good accountant should find them for you. Keep your receipts and keep up with the things that you spend money on throughout the year, and you will be well-prepared come tax time.
What tax credits or tax deductions have you used in the past?