Both tax deductions and credits serve as valuable tax saving tools for individuals and businesses, but there is a difference in how these two affect your total taxes.

Tax deductions

A tax deduction reduces the amount of income that is subject to tax and, in turn, becomes more valuable in a higher tax bracket. This means that if you are in the 25% tax bracket, for example, your savings on a $1,000 deduction would be $250 in taxes.

Things to consider:

• There are two types of tax deductions on an individual tax return - itemized and standard. Both are deducted from adjusted gross income.
• It would benefit you to itemize deductions if their total exceeds the amount of the standard deduction.
• The standard deduction amount depends on your filing status.
• You can claim a standard deduction on IRS form 1040, 1040A, or 1040EZ.
• There is an income limit for taxpayers who choose to itemize deductions. If your AGI is over a certain amount, your itemized deductions are reduced.
• You MUST document itemized deductions. This includes detailed record of property taxes, medical expenses, mortgage interest, non-business state income tax, and charitable donations.
• To calculate your itemized deductions, use IRS form 1040 schedule A.

Tax Credits
A tax credit reduces the actual tax you owe dollar-for-dollar, which proves more valuable tax-wise than a deduction in the same amount. This means that if you qualify for a $1,000 tax credit, it will save you exactly $1,000 in taxes ($750 more than a $1,000 tax deduction, based on the above 25% tax bracket).

Things to consider:

• While they appear to be the obviously more attractive option, they cannot reduce your income tax liability to less than zero. There are a few exceptions, however most tax credits are non-refundable, so any excess amount expires in the year the tax credit was used, meaning that the additional amount is not refunded to you.
• The benefits of tax credits depend on your filing status, income, deductions and tax liability. Each tax credit has different qualifications, so you may qualify for one credit but not another.
• Tax credits are less common than deductions, but cover things like buying your first home, child care expenses, home office expenses, and caring for elderly parents. There are also a number of business tax credits including The Rehabilitation Tax Credit, The Reforestation Tax Credit, and The Business Energy Tax Credit.

Which one is better?

While both serve to reduce your overall tax liability, tax deductions and credits are not interchangeable. The benefit of one over the other all depends on your income and expenses. It is important to understand the difference when filing your tax returns, but in the end, both can provide excellent tax savings.

For more information contact a member of our Tax Services Team.