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02.04.20

Do you know the differences between tax deductions and tax credits?

BY Darrell R. Kamholz, CPA

Tax deductions and tax credits both help in lowering your income tax bill so it is important to know the differences between them and know how to apply them to your tax situation.

Tax Deductions:

An income tax deduction reduces the amount of your taxable income. If you don't take the standard deduction, based on your filing status, then you will itemize your deductions on Schedule A. Common itemized deductions include medical expenses, state and property taxes, mortgage interest and charitable donations. Even if you don't itemize your tax deductions, you can take "above-the-line" deductions. Some common "above-the-line" deductions include educator expenses, health savings account contributions, deductible portion of self-employment taxes, contributions to qualified retirement plans, self-employed health insurance premiums, alimony paid (not executed or modified after 2018), deductible contributions to IRAs and student loan interest.

Tax Credits:

Tax credits are a direct reduction of your tax liability (dollar for dollar) and can be nonrefundable or refundable. A nonrefundable tax credit can allow you to reduce your tax liability to zero. A refundable tax credit would do the same but any remaining portion of the tax credit would be refunded to you. Some common tax credits include earned income tax credit (EITC), child tax credit, child and dependent care tax credit, American opportunity tax credit, retirement savings contributions credit, and foreign tax credit.

Knowing the differences and being educated on tax deductions and tax credits can have a big impact on reducing your tax liability or increasing your tax refund.

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Author

Darrell R. Kamholz, CPA

Professional Specialist

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