Imagine working hard and making a good income only to have to pay way too much in taxes. Before you let that happen, consider how you can use tax credits and deductions.
Not only that, but you should consider also the differences between a tax credit vs. tax deduction. That way, you’ll know how to take advantage of each when filing your taxes.
Read on to learn how each works.
Increase Your Tax Refund
A tax credit allows you to increase your tax refund or decrease your tax bill. The credit is a flat amount, so you don’t have to figure out how much you’ll owe in taxes after the credit.
Some credits only increase your refund or lower your tax bill. Others can apply whether you owe taxes or will receive a refund at tax time.
Common tax credits include the lifetime learning credit and the earned income tax credit. If you have a business in California, you can also access tax credits for research and development. Learn about R&D tax solutions here.
Tax credits are nice because they’re easy to understand. It doesn’t affect your tax bracket, so you don’t have to do as much math to determine how much you’ll owe each year.
Lower Your Taxable Income
A tax deduction can help you lower the amount of income subject to taxes. For example, a $5,000 tax deduction will lower the amount of income that taxes will affect.
It won’t necessarily mean you owe $5,000 less in taxes than you would have. Many people can deduct various things on their taxes, such as retirement savings, charitable donations, and health savings account contributions.
These deductions encourage people to contribute to certain accounts or donate to non-profits. The more you do those things, the more you can lower the income that you’ll have to pay taxes on.
Sometimes, you may be able to lower your taxable income to drop down to a lower tax bracket. While it’s hard to predict the savings, it can be an excellent way to save.
Tax Credit vs. Tax Deduction Examples
When comparing a tax credit vs. tax deduction, it helps to see some practical examples. Let’s start with a tax credit and assume someone earns $100,000 in a year.
A $5,000 tax credit would lower the person’s tax bill by $5,000. If they get a refund, they would get an extra $5,000 back.
Meanwhile, a $5,000 tax deduction would lower the person’s taxable income to $95,000. If they got another $10,000 deduction, that would reduce their taxable income to $85,000.
That’s enough to lower their income from the 24% tax bracket to the 22% bracket. So they could save even more on taxes with that extra deduction.
Now, the tax brackets aren’t flat, so they’d still only pay 10% on the first $10,275, for example. However, tax deductions can still lead to significant savings.
Take Advantage of Credits and Deductions
When filing your taxes, you should compare a tax credit vs. tax deduction. Luckily, you can take advantage of both to lower your taxable income and increase your refund.
If you do it right, you may be able to save a lot of money on taxes. Then, you can use the money for other expenses to help meet your goals.
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