With April 15 now less than a month away, it’s important to know how to file your taxes properly and claim all the credits and deductions you can. Unfortunately, most people still don’t know the difference, which can cost them hundreds or even thousands in unclaimed refunds.
The main difference is this: a tax credit reduces the amount of your tax liability, while a tax deduction reduces the amount of taxable income. At the bottom line, both are reducing the amount of taxes you pay and in theory they could save you an equal amount of money. However, the mechanics of how they’re calculated are different.
For example, say you made $50,000 last year and have no tax credits or deductions. Your tax rate would be 22%, so your tax liability would come out to $6,864. A tax credit then reduces the $6,864, while a tax deduction reduces the $50,000 (you would then recalculate to see what you owe).
The biggest difference in how they affect your tax return, then, is that a deduction could potentially lower your tax bracket. A single filer’s standard deduction is $12,200, and the cutoff between the 12% tax bracket and the 22% bracket is $39,475. Sticking with our previous example, the standard deduction would reduce your taxable income from $50,000 to $37,800. Your taxable income is now below the $39,475 threshold, so you would be taxed at 12% instead of 22% and your tax liability would be reduced to $4,345.
A tax credit, on the other hand, is a dollar-for-dollar reduction in your tax liability. Instead of lowering your taxable income and recalculating, if you owe $100 and you get a $100 credit then you owe $0. Credits can also be either refundable or non-refundable. A non-refundable credit could potentially reduce the amount you owe down to $0. A refundable credit meanwhile can reduce the amount you owe to $0, then refund you the difference if there is any leftover credit available.
The Child Tax Credit (CTC) is a common nonrefundable credit that could be worth up to $2,000. If you owe $1,500 and have a qualifying child, the CTC would reduce your liability to $0. What if you have more than one qualifying child though? The Additional Child Tax Credit is a refundable credit. For this let’s go back to our earlier example. You owe $4,345 and let’s say you have three children. You would receive $2,000 credit per child amounting to a $6,000 total. You would then be refunded $1,655 ($6,000 credit minus your $4,345 liability).
Of course, there are tons of different credits and deductions you can claim. Trying to research all of them and figure out which ones you qualify for can feel like its own full-time job. Still, it’s easy to see how drastically these credits and deductions can impact your tax return. You can miss out on valuable credits and deductions even if you’re using a tax software to calculate your taxes.
That’s where Peoples Tax comes in. Our tax professionals are trained by our sister company, The Income Tax School, and are up-to-date on all the latest tax laws, credits, and deductions. We will work with you to find all the best ways to help you pay the least legitimate amount of tax possible. Try our Virtual Tax Pro℠ Service or our Drop-Off Tax Service this year! All of our tax returns are double-checked and backed by our Triple Guarantee. Give us a call at (804) 204-1040 or email us with questions!