Tax Credit vs. Tax Deduction

When aiming to lower your overall tax bill, as a business or as an individual, the two main mechanisms are tax credits and tax deductions. They are treated differently, however, and this article will help you clearly understand the difference when it comes to a tax credit vs. a tax deduction.

Tax Credit

A tax credit is a direct reduction of your tax bill by a certain amount (dependent on the actual credit being used). If after completing your taxes you have a $10,000 tax bill, but then have $1,000 for some education or medical expenses, you would have a $9,000 tax bill afterwards.

Tax credits also typically fall into two categories that are treated very differently, refundable and non-refundable.
A refundable tax credit can, after all of your other taxable income and expense information is factored in, generate a cash refund back to you. A non-refundable credit can be used to reduce your overall taxes due, but cannot generate an actual cash refund back to you. Through non-refundable credits the best you could do is get to a zero taxes due position.

Many tax credits exist in most country's tax guidance ranging from health and education to environmental expenses.

Tax Deduction

A tax deduction does not directly reduce your tax bill but does through indirectly by being deducted from your taxable income. After calculating your taxable income that is the amount that then has your applicable tax rates applied to it and generates your actual taxes due. As such if you have $100,000 is income and $10,000 in deductions, you would have a taxable income of $90,000 remaining. With a 25% tax rate you would then have $22,500 in taxes due. In effect the deduction has a value to you of the tax rate multiplied by the deduction amount, so the $10,000 deduction above is worth $2,500 to you.

For personal and business taxes there are numerous deductions that you may be eligible ranging from mortgage and debt interest costs to charitable donations.

Tax Credit vs. Tax Deduction

From a face value perspective having tax credits is more beneficial than tax deductions when their amount is the same. A $10,000 tax credit provides more benefit than a $10,000 tax deduction. That said you don't have a choice when applying your expenses, you can get a deduction or a credit for certain expenses but would not be able to choose which.

Tax credits and tax deductions vary greatly from country to country and even from state to state. As such it is always recommended that anyone with even moderately complex taxes, personal or corporate, should engage a local tax professional to ensure they obtain the greatest benefit. The benefits of having your taxes reviewed or prepared by a tax professional can often find extensive savings in terms of structuring and recording the correct expenses.
By Jeffrey Glen

Copyrighted 2016. Content published with author's permission.

Posted in ...