You may often hear your friends, co-workers, or strangers talking about the various tax credits they get each year. Maybe you are gathering receipts in a box year after year, but you don’t know what for. Perhaps you’ve heard about tax deductions and you just don’t know what that means, or what you qualify for.
With all of the various terms used with the IRS to indicate areas where you can save on your tax filing it’s no wonder you get confused.
Today we are explaining these terms so that you can understand them, and maybe they will help you as you file your tax returns this year.
The good news is that tax deductions and credits both reduce your tax liability. But those reductions happen in different ways.
Summing Up Tax Deductions and Credits
There are two types of tax deductions.
The first is the standard deduction.
It is a given amount that reduces the amount of income that you claim. The amount is pre-determined based upon the type of status you file. Allowances are given for a couple, filing jointly, and individuals are also allowed a specific amount but it varies based on a number of factors, like disability or age.
The amount, based upon those pre-determined variables, is then reduced from the amount of income that you earned, thus reducing your tax liability.
The second is itemized deductions.
Note: You can’t take a standard deduction if you are taking itemized deductions.
Once your adjusted gross income is calculated, you can itemize deductions based upon an allowable list of items that can reduce your tax liability. You then subtract those expenses from the adjusted gross income to arrive at the amount of your tax liability.
In order to take itemized deductions a tax payer must maintain records of the expenses which they seek to itemize.
- Medical expenses that do not exceed 10% of the adjusted gross income. There is a list of pre-determined allowable expenses that may be deducted. Not all medical expenses are allowable.
- Stade and local taxes paid, including income, property, sales, use, excise taxes, as well as late fees, fines and penalties.
- Mortgage interest expenses on debt for up two homes.
- Investment interest, up to the amount of income reported from investments,
- Charitable contributions to allowable recipients; this deduction is limited to either 30% or 50% of AGI. Allowable recipients include; churches, government entitiies, charitable organizations such as veterans organizations, disaster relief organizations, poverty relief organizations and others.
Summing up Deductions
- Reduce the amount of your taxable income
- You can take either the standard deductions or itemized deductions. You cannot take both.
- The pre-determined amounts are set based upon your tax bracket.
(A pre-determined range of income amounts).
- The deduction amount cannot reduce your tax liability to below $0.
Determining which to take is usually based upon which one would be the greater amount. If itemizing deductions exceed the amount of the standard deduction then it is in your best interest to itemize. If, however, the standard deduction is higher it is in your best interest to take the standard deduction.
A tax credit allows you to reduce your tax liability by allowing you to claim certain expenses. These are things that you pay for out of your own pocket. You can then subtract the amount of the tax credits from the amount of tax you owe.
There are two types of tax credits:
- A non-refundable tax credit means you get a refund only up to the amount you owe for taxes.
- A refundable tax credit means you get a refund, even if it is more than what you owe, and the excess is returned to you.
There are a variety of types of tax credits, these include, but not limited to:
- Earned Income Tax Credit
- Education Credits
- Child and Dependent Care Credit
- Adoption Credit
- Savings Credit
- Work or Business Credits
- Health Care Credits
Summing Up Credits
- Directly reduces the amount of the tax you owe.
- You do not have to itemize in order to take a tax credit.
- Some are non-refundable and you may not get a refund for more than the amount owed.
- Some are refundable and may allow you to get a refund greater than the amount you owed.
- Are Dependant upon things like your age, employment, filing status, educational situation of your children.
- Are valued by a pre-determined dollar amount.
Whether you are taking tax deductions or tax credits know that both of them allow you to reduce the amount of tax that you owe the federal, state, or local governments. When filing those reductions of tax liability is what determines whether or not you have already paid enough through your payroll taxes, if you still owe, or if you are owed a refund.
Call Cowdery Tax today to schedule your appointment and we will help you determine which deduction, or credits you are eligible for: 740•374•6942.
Photo Credit: Flickr.com 'PT Money' ptmoney.com