While a deduction can reduce the amount of taxable income, credits can directly reduce the amount of tax owed, dollar for dollar, so they offer a greater tax benefit.
Here’s the difference between tax credits and tax deductions:
Both reduce your tax bill, but in very different ways.
For instance, a tax credit valued at $1,000 lowers your tax bill by the corresponding $1,000. Tax deductions, on the other hand, reduce how much of your income is subject to taxes.
Deductions lower your taxable income by the percentage of your highest federal income tax bracket.
So if you fall into the 22% tax bracket, a $1,000 deduction saves you $220.
Sometimes, credits can be refundable, which means that they might generate a refund for you even when you don’t owe tax.
But, some tax credits are non-refundable.
That means that if you don’t owe a lot in taxes to begin with, you don’t get the full value of the credits.
For example, a $600 tax bill combined with a $1,000 non-refundable credit doesn’t get you a $400 tax refund check. It just results in no tax due.
Below are examples of different tax credits and deductions available for individual taxpayers.
Remember that each credit and deduction has specific criteria that need to be met to qualify.
Credits for Individuals
- Child Tax Credit
- Dependent Care Credit
- Earned Income Tax Credit
- Adoption Credit
- Saver’s Credit
- Foreign Tax Credit
- Excess Social Security and RRTA tax withheld
- Credit for Tax on Undistributed Capital Gain
- Credit for Prior Year Minimum Tax
- Residential Energy Credits
- Plug-in Electric Drive Vehicle Credit
- Premium Tax Credit (marketplace health care insurance credit)
- American Opportunity Credit and Lifetime Learning Credit
If you feel you might qualify for one of these credits, be sure to ask us about them!
Deductions for Individuals
The IRS provides each taxpayer with a standard deduction that reduces their adjusted gross income, so they pay less tax.
The amounts change each year and are determined by filing status.
In the 2022 tax year, here is a sampling of the standard deduction amounts.
Single; Married Filing Separately $12,950
Married Filing Jointly $25,900
Head of Household $19,400
In 2023, these amounts increase to :
Single; Married Filing Separately $13,850
Married Filing Jointly $27,700
Head of Household $20,800
Regarding the 2023 increase, the Wall Street Journal reported, “This is the largest automatic adjustment to the standard deduction since core features of the tax system were first indexed to inflation in 1985.”
Most taxpayers take the standard deduction, but the law allows you to take more if you have more qualifying deductions than the limits above.
These tax breaks are called itemized deductions.
By itemizing, you are giving up the standard deduction – you can’t take both.
Instead, you are opting to take the specific expenses you can use as deductions and list them on your tax return.
Some of the more common itemized deductions include: personal property tax, real estate tax, sales tax, charitable contributions, gambling losses, interest expense, home mortgage interest paid, and moving expenses, to name a few.
Students and teachers may be able to take education deductions, which include student loan interest paid, work-related educational expenses, and educational expenses paid by a teacher.
Self-employed individuals can claim work-related deductions related to business expenses, business use of car, and business use of home on Schedule C.
Healthcare deductions, such as medical and dental expenses or Health Savings Account (HSA) contributions, can be deductible to those participating in these plans.
For investors, deductions may include sale of home, Individual Retirement Arrangement (IRA) contributions, capital losses, bad debts, qualified opportunity zone investments, and debt forgiveness.
If you’d like to study deductions and credits on your own, the IRS website is a wealth of knowledge.
Or, you can always ask us!
Remember – thoroughly filling out your tax organizer is the first step to helping us identify the credits and deductions you may qualify for.