Tax Credits vs. Tax Deductions

Migrant Resources

Tax Credits vs. Tax Deductions

Do you know the difference between credits and deductions? Read to find out!

There is one thing to love about doing your taxes–the chance of getting money back.

True, not all of us get a tax return. But when you do, there’s no better feeling than getting a check from the US government.

What’s the trick to getting money back when you file your taxes?

Easy. It’s knowing about tax credits and tax deductions and which ones you can claim.

To get you started on the road to a big, fat tax return, we’ll break down tax credits vs deductions so you can get the money back you deserve!

What is a tax credit?

A tax credit is a sum of money you are allowed to subtract from the total amount of taxes you owe to the government.

A credit is actually better than a deduction.

Why?

Because credits reduce the total tax due, rather than just reducing your total taxable income. It would be like if you went to the store and you owed $30, but you use a $5 off coupon to bring your total down to $25. Simple enough.

There are three different types of tax credits:

  1. Nonrefundable
  2. Refundable
  3. Partially refundable

A nonrefundable tax credit reduces the amount you owe until your total is $0. However, it does not bring your total below zero which would result in money back. To continue with the example above, if your total comes to $3 and you use your $5 off coupon, your total would drop to $0, but you would not get $2 back.

Some nonrefundable tax credits include credits for adoption, Child and Dependant Care Credit, and the mortgage interest credit.

On the other hand, refundable tax credits allow you to subtract what you owe to below $0, and every dollar below $0 is owed back to you. So it would be like using your $5 coupon on a $3 purchase and the store owing you $2 back. Pretty sweet deal, right?

Examples of refundable tax credits are the Earned Income Tax Credit and the Premium Tax Credit.

Finally, partially refundable tax credits can both decrease your taxable income and reduce the amount you owe. The American Opportunity Tax Credit (AOTC) for post-secondary education is a prime example.

To ensure you never miss a tax credit, check out the Complete List of Tax Credits to find out which ones you can claim!

What is a tax deduction?

A tax deduction lowers the amount of your taxable income. For example, if you earned $20,000 over the year, that is the amount on which you will owe taxes. However, if you include deductions, usually certain eligible expenses you paid throughout the year, you can subtract them from your total and might only be taxed on $15,000 instead. It all depends on how many deductions you have.

Even though tax credits are better, tax deductions are pretty great too because it still means you will owe less taxes in the end.

There are two types of deductions–a standard deduction and an itemized deduction.

Most individual filers will receive a standard deduction on their federal taxes. The amount is already set by the Internal Revenue Service (IRS), so there is no need for a calculation.

In comparison, itemized deductions are a little trickier because they require more work. Usually, individuals will go with a standard deduction unless they file jointly with someone else, have a lot of job-related expenses, pay major medical bills, or own property.

Because tax deductions are a tiny bit more complicated, there’s a lot of deductions you can forget. So before you finish filing your taxes, check out 5 tax deductions you shouldn’t miss!

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