In the realm of taxation, understanding the distinctions between tax credits and deductions is crucial because these two concepts help determine your tax liability and potential refunds. Are you certain about the matter? In this blog, we will explore what tax credits and deductions are, why they matter, and how you can benefit from them.
A Closer Look at Credits
Tax credits are financial incentives provided by governments to promote certain behaviors or assist specific groups of taxpayers. Read our blog, “Tax Credits: A Guide to the Basics”, for a high-level introduction. Unlike deductions, which reduce taxable income, tax credits directly reduce the amount of tax you owe. They can be particularly valuable because they offer a dollar-for-dollar reduction in your tax liability.
Types of Tax Credits
Tax credits come in various forms. While there are many available, some of the most common include:
The Earned Income Tax Credit (EITC) aims to provide a tax break for individuals and families with low to moderate incomes. Criteria to qualify in 2023 include earning income under $59,187 and having investment income below $10,300 for the year. Other stipulations apply, so consult with your CPA to determine eligibility and your credit amount.
Education Tax Credits provide financial relief to individuals pursuing higher education. The most notable examples include the American Opportunity Credit and the Lifetime Learning Credit. These credits can offset the costs of tuition and related expenses.
Child Tax Credits provide tax relief for each qualifying child. This credit has undergone several changes over the years, most recently with amended values due to the Covid-19 pandemic.
Energy Tax Credits encourage energy-efficient practices and incentivize homeowners and businesses to adopt environmentally friendly technologies, like solar panels or energy-efficient appliances.
Business Tax Credits reward businesses for specific activities, such as research and development (R&D) or hiring from targeted groups of workers. Read more from our blogs on small business taxes here.
A Deep Dive on Deductions
Deductions, on the other hand, reduce your taxable income. What does this mean? They can lower the total amount of income that is subject to taxation. Deductions are subtracted from your gross income to arrive at your taxable income, which may potentially place you in a lower tax bracket and reduce your overall tax liability.
Types of Deductions
Just like tax credits, there are several tax deductions for taxpayers to claim. Some of the most common deductions include:
The Standard Deduction is a predetermined deduction amount that varies based on your filing status.
Itemized Deductions include a range of eligible expenses, such as mortgage interest, medical expenses, state and local taxes paid, and charitable contributions.
Why Tax Credits and Deductions Matter
Tax credits and deductions are significant because they affect your financial obligations to the government and can result in either lower taxes owed or increased tax refunds. As a taxpayer, you should have a grip on these concepts to prepare for tax filings accurately and plan a tax strategy that benefits you.
Understanding these deductions can help you be more financially aware as you make decisions that may impact them. Because tax credits and deductions directly impact your finances, you also should be aware of the specific criteria required to qualify for such components and know what records to save in preparation for filing.
Get Expert Advice from KPN
Tax credits and deductions are valuable tools in the world of taxation. Understanding the differences between these concepts is essential for effective tax planning and compliance. Consult with tax professionals or refer to official tax guidelines for guidance specific to your tax situation. The tax professionals at KPN are always available to help. Contact us to get your tax journey on the right path. Our tax services will ensure your taxes are filed appropriately with the credits applicable to you.