As the New Year begins, it’s a great time to focus on planning your taxes. A big part of this is knowing the difference between tax deductions and tax credits. Understanding these can make your tax payments more efficient, ultimately boosting your household’s finances.
**Tax Deduction**
Tax deductions help reduce the income you owe taxes on by subtracting certain expenses from your gross income. There are two main types of deductions. The first, known as “above the line” deductions, are calculated on the first section of your Form 1040 and contribute to figuring out your adjusted gross income. The second type involves deductions on the next part of Form 1040, which include either the standard deduction or the itemized deductions on Schedule A. These help further lower your income and figure out what your taxable income is.
**Tax Credit**
Unlike deductions, tax credits directly decrease the amount of tax you owe. After finding your taxable income and calculating your tax due from tax tables, you can apply tax credits to cut down on your total bill. Think of a tax credit as using a gift card to lower what you owe directly. If your tax credits are larger than what you owe, you might get a refund from the government. Since tax credits reduce your bill dollar for dollar, they are often more advantageous than deductions.
**Tax Advantages**
To get the most out of tax deductions and credits, keep track of eligible expenses all year long. Save all important receipts and documents in case you ever need to explain your claims during an audit. As you look forward to the upcoming year, include tax credits and deductions in your financial planning so you can gather them throughout the year instead of rushing at the end. For making well-informed choices, it might be a good idea to talk to a qualified tax advisor.