What do tax deductions and tax credits have in common? Well, both can lower your tax bill, and both are considered tax breaks.
How are they different? We talk about that below.
Tax deduction defined
A tax deduction is a personal or business expense that lowers your income subject to tax. It’s an expense that’s deducted before you calculate your taxable income. That means, you should subtract any tax deductions from your income before you compute your tax bill.
Let’s break it down further because on your tax return, you’ll have to choose between one of two types of deductions. To do that, you’ll need to know which deduction type benefits you the most financially.
You’ll either take the standard deduction, which is a fixed amount, or you’ll itemize your deductions.
A standard deduction lowers your income that will be taxed, but the amount of the standard deduction depends on a few factors:
- Filing status
- Age of taxpayer and spouse
- Whether the taxpayer or spouse is blind
- Whether the taxpayer can be claimed as a dependent on someone else’s tax return
For example, taxpayers over age 65 who are blind are eligible for an increased standard deduction. On the other hand, taxpayers who can be claimed as a dependent on someone else’s tax return may receive a lower standard deduction.
Know your filing status because it will determine your standard deduction amount.
Standard deduction table for 2017 taxes
|Filing Status||Standard Deduction|
|Married Filing Separately||$6,350|
|Married Filing Jointly||$12,700|
|Head of Household||$9,350|
Note regarding the table above: Different rules apply for taxpayers born before January 2, 1953, taxpayers who are blind, and taxpayers who can be claimed as dependents on someone else’s tax return.
Itemized deductions are trickier because you must keep detailed records to corroborate the itemized deductions you list on your tax return.
Examples of itemized deductions:
- Work-related education expenses
- Business travel & entertainment expenses
- Casualty, disaster, and theft loss
- Business use of your home or car
- Miscellaneous expenses
- Charitable giving expenses
- Interest expenses
- Home mortgage points
- Medical & dental expenses
- Deductible state, local, and foreign income taxes
It’s good to itemize if your total deductions exceed your standard deduction amount, or if you don’t qualify for the standard deduction. If you do itemize your deductions, fill out Schedule A and submit it with your Form 1040.
Keep in mind your itemized deductions may be limited depending on your adjusted gross income (AGI).
Tax credit defined
A tax credit is a dollar-for-dollar reduction in tax that can be subtracted from the tax you owe. That means, you can take the amount of taxes you owe—your tax bill—and subtract those tax credits.
A credit will fall into one of two categories:
- Non-refundable tax credit: the refund you get can only reach the amount you owe
- Examples: Adoption tax credit, child tax credit
- Refundable tax credit: the refund you get can exceed what you owe
- Examples: Additional child tax credit (ACTC), earned income tax credit (EITC)
Refundable tax credits are better because if the credit you claim is more than your total tax bill, you can keep the difference.
Is one tax break better than the other?
One tax break isn’t necessarily better than the other. A tax break is a tax break. Every little bit helps, right?
We all fall into a different income bracket and must manage finances related to major life events, career changes, relocations—all of which impacts our taxes. A deduction type that works one year might not be beneficial the next year. We might meet eligibility requirements for one credit this year but not the next, and so on.
The best thing you can do before the start of tax season is research every credit and every deduction you can take for that particular year.
So now you know the difference between a credit and a deduction. Who’s ready to slay their taxes?
Updated February 16, 2018