Tax season is here. However, before you file, it’s best to know which deductions and credits you may qualify for. Most of us can take a glance back at last year’s filings and get a general idea, but if your status has changed, e.g. having a child, getting married, getting divorced and etc., your eligibility can change.
Let’s take a look at the difference between tax deductions and tax credits.
Tax deductions can reduce the amount of your income BEFORE you calculate your tax debt. Simply, it lowers your taxable income. How can this benefit you? (1) Your taxable income is decreased, but you remain in the same tax bracket. Taxes owed decreases because the marginal tax rate is applied to a lower taxable amount. (2) Your taxable income is reduced plus you move to a lower tax bracket. Not only is your taxable income less, but you also have a lower tax rate.
The most common deduction is the Standard Deduction. Per the IRS website, the standard deduction for married couples filing jointly for tax year 2023 rises to $27,700 up $1,800 from the prior year. For single taxpayers and married individuals filing separately, the standard deduction rises to $13,850 for 2023, up $900, and for heads of households, the standard deduction will be $20,800 for tax year 2023, up $1,400 from the amount for tax year 2022. ~ Source: Internal Revenue Service
On the other hand, tax credits can reduce the amount of tax you owe or increase your tax refund, plus certain credits may provide a refund even if you don’t own any tax. They are a dollar-for-dollar reduction to your tax bill and come in two forms, refundable and non-refundable. The best way for me to explain the difference is with an example. Let’s say you owe $1,000 in taxes, but you qualify for a $1,500 credit. If the credit is refundable, it would cover your $1,000 tax debt and you would receive a tax refund of $500. If the credit is non-refundable, your tax bill would be reduce to zero, and you wouldn’t owe any taxes, but the remaining $500 would not be refunded.
Most experts prefer tax credits over tax deductions, primarily because of the direct reduction in your tax bill and they can be refundable. However, I say, whatever you can legally qualify for, whether it’s a deduction or credit, take full advantage of it. They both work to reduce your tax burden and that is definitely a good thing.
For more information check out the Credits and Deductions for Individuals on the IRS website.
Until Next Time♥…
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