Tax Credits & Tax Deductions http://www.cpa-cfa.

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There are two ways of lowering your tax bill to the IRS: tax credits and tax deductions. Understanding the difference between the two is important to maximize your savings. Difference between Tax Credit and Tax Deduction A tax credit is a dollar for dollar reduction in your taxes. If you have a $1000 tax credit, you will pay $1000 less in taxes. For example, if you owe $3000 in taxes, a $1000 tax credit will reduce the amount you owe the IRS to $2000 A tax deduction reduces your taxes by decreasing your income. A simple way to figure out your tax savings is to use this tax deduction formula: Reduction in taxes = Tax Deduction * Marginal Tax Rate Using the same numbers as above, if you owe $3000 in taxes and are in the 28% tax bracket, a $1000 tax deduction will result in $280 of tax savings ($1000 *.28). Reducing the amount you owe the IRS to $2,720. Tax Credit vs Tax Deduction A tax credit is better than a tax deduction 99.99% of the time. In fact, a tax credit is much better than a tax deduction 99.99% of the time. Tax credits are not subtracted from taxable income but directly from an individual’s tax liability - thus reducing taxes dollar for dollar. That said, there are rare instances when a deduction will be more valuable to an individual. Tax deductions are worth more to tax payers in higher tax brackets. A deduction is worth more to an individual in the 35% tax bracket compared to the 10% tax bracket. So if there was a scenario for an option to either receive a $250 credit tax or a $1000 tax deduction, an individual in the 35% tax bracket should take the deduction to reduce taxes by $350. Another case in which deductions may be more valuable than credits are deductions that reduce AGI (Adjusted Gross Income), these include contributions to Traditional IRAs, 401(k)s and student loan interest. If you’re making around $120,000 a year (single filer), reducing AGI may make you eligible to invest in a Roth IRA. Double check the Roth IRA contribution limits before investing.

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