Tax deductions vs tax credits
There are tax deductions and there are tax credits. The difference between tax deductions and tax credits is huge. These will provide important tax benefits that can help reduce your tax bill.
Tax deductions lower your taxable income by reducing the income that is subject to tax. For example, if you claim a $1,000 deduction, and your marginal tax rate is 25%, you will save $250 in taxes.
With tax credits, you save dollar for dollar. For example, if you claim a $1,000 credit, you will save $1,000 in taxes. Tax credits can be refundable or non-refundable, which means if the credit amount is more than your tax liability, the nonrefundable credit will only reduce your tax liability to zero. Your ability to qualify for a particular tax credit depends on several factors, including your income, age, and tax filing status.
Understanding Tax Deductions: What They Are and How They Benefit You
Tax deductions are a way for taxpayers to reduce their taxable income and lower their overall tax bill. They are expenses that the government allows you to subtract from your income before determining how much tax you owe. Deductions, based on your tax bracket, can help you pay less in taxes by reducing your taxable income and taking advantage of tax breaks.
Here are some common examples of tax deductions:
- State and local taxes: This can be a significant deduction for taxpayers who live in states with high taxes.
- Mortgage interest: This can be a substantial deduction, especially in the early years of your mortgage when most of your payments go towards interest.
- Charitable contributions: You can deduct charitable donations from qualified organizations such as churches, schools, and non-profit groups.
- Medical and dental expenses: You can deduct expenses exceeding 7.5% of your adjusted gross income. This includes expenses such as doctor’s visits, prescription drugs, and medical equipment.
- Job search expenses: If you are looking for a new job, you can deduct certain expenses related to your job searches, such as resume preparation and travel expenses.
Maximizing Your Tax Deductions: Commonly Overlooked Expenses
Maximizing your tax deductions is important in reducing your tax bill and keeping more of your hard-earned money. However, it can be easy to overlook certain deductions that may be available to you. Here are some commonly overlooked tax deductions that individuals may be able to claim:
State and local taxes: This can be a significant deduction for taxpayers who live in states with high taxes.
Mortgage interest: This can be a substantial deduction, especially in the early years of your mortgage when most of your payments go towards interest.
Charitable contributions: You can deduct charitable donations from qualified organizations such as churches, schools, and non-profit groups.
Medical and dental expenses: You can deduct expenses exceeding 7.5% of your adjusted gross income. This includes expenses such as doctor’s visits, prescription drugs, and medical equipment.
Home office expenses: If you work from home, you can deduct a portion of your rent, mortgage interest, utilities, and other related costs. To qualify, you must use a specific area of your home exclusively for business purposes.
Education expenses: Taxpayers can claim deductions for education expenses such as tuition, books, and supplies if their job requires them or if they are going to school to improve their job skills.
Navigating Tax Credits: How They Differ from Deductions and How to Claim Them
For example, if you claim a $1,000 credit and owe $4,000 in taxes, your tax bill will be reduced to $3,000. Tax credits can be more valuable than deductions because they can save you more money.
A refundable credit means that if the credit amount exceeds your tax liability, the government will give you the remaining amount as a refund. A non-refundable credit, on the other hand, will only reduce your tax liability to zero, and you can’t receive a refund for the unused credit.
Child Tax Credit: This credit is available to taxpayers with a qualifying child under 17. The credit amount is $2,000 per child, and up to $1,400 can be refundable.
American Opportunity Tax Credit: This credit is available to taxpayers paying for college or vocational school. The credit amount is up to $2,500 per student and is partially refundable.
Lifetime Learning Credit: This credit is available to taxpayers paying for undergraduate, graduate, or professional degree courses or courses to acquire or improve job skills. The credit amount is up to $2,000 per tax return and is non-refundable.
The credit amount is based on your income and the cost of care.
Adoption Credit: This credit is available to taxpayers who adopt a child. The credit amount is up to $14,440 per child and is non-refundable.
Education Tax Credits: Understanding the American Opportunity Tax Credit and Lifetime Learning Credit
Additionally, the student’s modified adjusted gross income (MAGI) must be within certain limits.
The Lifetime Learning Credit (LLC) is a non-refundable credit of up to $2,000 per tax return per year for any post-secondary education. This includes undergraduate, graduate, or professional degree courses or courses to acquire or improve job skills. LLC can be claimed for a student, and the student does not need to be enrolled in a college. You must choose which credit to claim and which student’s expenses to apply it to.
You will also need to provide documentation such as tuition statements, 1098-T forms, and other education-related expenses like books and supplies.
Child Tax Credit vs. Child and Dependent Care Credit: Which One Applies to You?
However, they have different eligibility requirements and provide different types of benefits.
The Child Tax Credit is a credit of up to $2,000 per qualifying child under 17. The credit is partially refundable, meaning that if the credit exceeds the amount of taxes you owe, you may receive a refund for a portion of the remaining credit.
On the other hand, the Child and Dependent Care Credit is a credit of up to 35% of eligible expenses for the care of a qualifying child under age 13 or you work or look for work. The credit is non-refundable, meaning it can only result in a refund. The credit is limited to $3,000 in expenses for one dependent and $6,000 for two or more dependents. Other credits cover the expense of child and dependent care as well as education credits. If you will not be eligible to claim the Child Tax Credit on your 2021 return (the one due in April of 2022), then you should go to the IRS website to opt out of receiving monthly payments using the Child Tax Credit Update Portal.
Charitable Contributions: How to Properly Deduct Donations on Your Tax Return
However, it’s important to understand the rules and regulations for deducting donations on your tax return.
First, it’s important to note that you must deduct charitable contributions. This means you cannot claim a charitable contribution deduction if you take the standard deduction.
Next, the organization you donate to must be a qualified charitable organization. This includes most religious, charitable, educational, scientific, or literary organizations and organizations that work to prevent cruelty to children or animals. You can check the tax-exempt status of an organization using the IRS’s Exempt Organizations Select Check tool.
You will also need to keep records of your donations. Donations of cash or property valued at less than $250, a cancelled check, bank or credit card statement, or written communication from the charity showing the name of the charity, the date, and the amount of the contribution is enough. For donations of cash or property valued at $250 or more, you will need a written acknowledgment from the charity that includes the amount of the donation and whether the charity will depend on the type of donation and the type of property donated.
For example, donations of cash or property that have been used for a charitable purpose are generally deductible at fair market value, while donations of appreciated capital assets are generally deductible at fair market value, subject to certain limits.
There are limits on the number of charitable contributions you can deduct on your tax return. For cash donations, the limit is generally 60% the limit is generally 30% of your AGI for the year.
Homeowner Tax Deductions: Mortgage Interest, Property Taxes, and More
As a homeowner, there are several tax deductions that you may be eligible to claim. These deductions can help to offset the cost of homeownership and potentially lower your overall tax liability.
One of the most common deductions for homeowners is the mortgage interest deduction. Mortgages up to $1 million for mortgages taken out before December 15, 2017.
Another common deduction for homeowners is the property tax deduction. This deduction allows you to deduct the property taxes you pay on your primary residence from your taxable income, including state taxes. It’s important to note that this deduction is capped at $10,000 for the tax year 2018 through 2025 under the Tax Cuts and Jobs Act of 2017. Additionally, if you have paid interest on your student loans, you may be eligible for the student loan interest deduction, which allows borrowers to write off up to $2,500 from their taxable income.
In addition to the mortgage interest and property tax deductions, homeowners may also be eligible to claim deductions for home improvement costs, energy-efficient upgrades, federal income tax credits, and mortgage points. Home improvement costs, such as remodeling or adding a room, can be added to your tax basis in the property, thus reducing the capital gains tax when you sell your home. Energy-efficient upgrades can be eligible for a tax credit of up to $500. Mortgage points are prepaid interest that you pay at closing to lower your mortgage interest rate. These points can be deducted in the year you pay them if they meet certain qualifications.
Small Business Tax Deductions: Common Expenses Eligible for Deduction
These deductions can help to offset the costs of running your business and potentially lower your overall tax liability.
One of the most common deductions for small businesses is the cost of goods sold (COGS) deduction. This deduction allows you to deduct the direct costs of producing or purchasing the goods you sell. This includes the cost of raw materials, labor, and expenses directly related to producing the goods.
Another common deduction for small businesses is the home office deduction for the use of your home.
Small businesses may also claim deductions for vehicle expenses, such as gas, repairs, and insurance. Suppose you use your vehicle for both business and personal use. In that case, you’ll need to calculate the percentage of time the vehicle is used for business and only deduct that percentage of the expenses.
Small businesses may also be eligible to claim deductions for travel expenses, such as lodging and transportation. The only requirement is that it is for business purposes. Business meals and entertainment expenses are also deductible, but only up to 50% of the cost is deductible under new tax laws.
Other common deductions for small businesses include employee salaries and benefits, rent, and office supplies.
Saving on Taxes with Retirement Plan Contributions: IRAs, 401(k)s, and More.
Saving for retirement is not only important for financial security, but it can also be a great way to save on taxes at tax time. Individual Retirement Accounts (IRAs) are one of the most popular retirement savings plans. Withdrawals from a traditional IRA in retirement are taxed as income. On the other hand, contributions to a Roth IRA are not tax-deductible.
401(k) plans are another popular type of retirement savings plan. An employer sponsors these plans, and employees can make contributions through payroll deductions. Contributions to a 401(k) plan are made pre-tax, which means that the money is not taxed in the year it is contributed at the federal level. The money in a 401(k) plan also
In addition to traditional and Roth IRAs and 401(k) plans, there are other types of retirement plans that offer tax benefits, such as Simplified Employee Pension (SEP) plans, SARSEP plans, and Simple IRA and Profit-Sharing plans.
State and Local Tax Deductions: How They Affect Your Federal Tax Return
State and local taxes, also known as SALT taxes, can impact your federal tax return. The federal tax code allows taxpayers to deduct certain state and local taxes from their income, which can lower their overall tax liability.
The most common state and local taxes are state and local income taxes and state and local property taxes. This means that if you paid to state and local income taxes or property taxes during the tax year, you could deduct the amount you paid on your federal income tax return. It’s important to note that you can only claim either state and local income taxes or state and local sales taxes, not both.
Additionally, you there is a cap on state and local taxes that can be deducted from your federal tax return. For the tax year 2021, the cap is $10,000. This means that you are limited to $10,000 no matter how much you really paid.
Conclusion
Tax deductions and tax credits can save you money when filing your small business tax return. A tax deduction reduces your taxable income while you owe. Both deductions and credits can lower your overall tax bill, but credits are generally more valuable because they directly reduce the amount of taxes you owe, dollar-for-dollar. Examples of deductions include expenses related to your job or business, mortgage interest, and charitable donations. Examples of credits include the child tax credit and the earned income tax credit.
FAQs
What is the difference between tax deductions and tax credits?
Tax deductions and tax credits are both ways to reduce your tax liability, but they work in different ways. The tax deductions lower your taxable income, reducing the amount of income that is subject to tax. Tax credits, on the other hand, directly reduce the amount of tax you owe.
What are some common tax deductions that individuals can claim on their taxes?
Some common tax deductions that individuals can claim on their taxes include mortgage interest, student loan interest, medical expenses, charitable contributions, and state and local tax deductions. These deductions can help reduce your taxable income and potentially lower your tax liability.
Can I claim both tax deductions and tax credits on my taxes?
Yes, you can claim both tax deductions and tax credits on your taxes. Tax deductions reduce your taxable income, while tax credits directly reduce the amount of tax you owe. By taking advantage of both deductions and credits, you can maximize your tax savings and potentially receive a larger refund.
What documentation do I need to provide when claiming a tax deduction or tax credit?
When claiming a tax deduction or credit, you will typically need to provide supporting documentation such as receipts, invoices, and financial statements. It’s important to keep accurate records and retain these documents in case of an audit or if the tax authorities require further verification.
