Explaining Tax Credits and Tax Deductions

No matter if a professional does your taxes or you do it yourself with software, everyone has the same general goal to reduce their tax burden. Here's a look at how tax deductions and tax credits differ in how they reduce the taxes you owe.

Taxes are complicated, which is why most people get help from professionals. However, everyone has the same general goal: to reduce their tax burdens in some way.

Ideally, you should be considering ways to reduce your taxable income throughout the year by putting money into accounts like 401(k)s or by gifting money to family members.

However, if you neglected to make the moves during the year, there are still two ways to reduce your tax burden: tax deductions and tax credits. They sound similar, so they could be easy to mix up, but they work very differently. Here's a basic explanation of how they work.

Deductions

Like those moves you should have been making during the year, deductions reduce your taxable income. According to MoneyCrashers.com, deductions cut your taxes into broad categories like:

• Medical expenses

• State and local income taxes

• Property taxes

• Mortgage interest

• Charitable contributions

You can go the route of simply using the standard deductions, but you could be cheating yourself out of money. If you itemize your deductions, you could see a lot more money going back into your account.

However, itemizing deductions isn’t for everyone. If you didn’t have any large medical expenses or charitable donations or you don’t pay home mortgage interest, then it might be better to simply take the standard deduction:

Married couples filing jointly: $11,900

Single/married filing separately: $5,950

Head of household: $8,700

Credits

After you figure out your new taxable income post-deductions, you calculate how much tax you owe. This is where tax credits come in — they directly reduce the taxes you owe. There are a multitude of tax credits such as:

Green energy tax credits

Earned income credit

Child tax credit

Tax credits are split into refundable and non-refundable. Non-refundable tax credits can bring your tax liability to zero, while refundable tax credits could mean the government owes you money.

It is recommended that you speak with your advisor or check IRS guidelines about eligibility for tax credits and deductions.

Read more:

Year-End Tax-Saving Moves for Physicians

What is a Tax Credit vs. a Tax Deduction? - Money Crashers