08 Jun What Are Credits and Deductions For Tax Purposes?
Tax documents are currently arriving in mailboxes and inboxes, reminding us all that tax season is rapidly approaching. This article will give a brief and broad overview of what credits and deductions are all about. The federal tax code allows for certain “credits” and “deductions” in an attempt to make income tax reflect a taxpayer’s ability to pay, and for public policy reasons.
Understanding the difference between tax credits and tax deductions is important. Tax credits directly reduce the amount of tax a taxpayer owes. Credits are highly beneficial in that they provide the taxpayer with a dollar-for dollar reduction of tax liability. Tax deductions, on the other hand, reduce the amount of a taxpayer’s income that is subject to taxation. So, many deductible items are really only deductible up to a percentage of the amount of the expenditure.
As for credits, some are non-refundable, meaning they can only be taken to the extent that they lower tax liability to zero. However, other tax credits are refundable, meaning they can lead to a tax refund if they lower tax liability below zero.
Among the tax credits that may be available to a taxpayer are the Earned Income Credit, the American Opportunity Credit, the Child Tax Credit, the Child and Dependent Care Credit, the Premium Tax Credit, the Lifetime Learning Credit, and others.
As for deductions, there are two different kinds. Some are known as “above-the-line” deductions because they directly lower your income before calculating your adjusted gross income that is subject to taxation. These are the most advantageous kinds of deductions for the taxpayer. Others are known as “below-the-line” line deductions because they are calculated based on your adjusted gross income. Simply put, they are not as advantageous.
As for the below-the-line deductions, each taxpayer is entitled to a standard deduction, the amount of which depends on several factors. Because the standard deduction has been increased significantly in recent years, it sometimes has the effect of preventing a taxpayer from itemizing deductions that might have been taken otherwise. However, if a taxpayer has significant enough deductions, he or she still may be able to itemize deductions for a wide variety of items.
The list of potential tax deductions is long. Among them are certain medical and dental expenses, charitable contributions to tax-exempt organizations, mortgage interest payments, college tuition and fees, contributions to a traditional IRA, and property and real estate taxes paid. Certain losses are also deductible including business losses, gambling losses, and theft. However, specific rules apply to how to claim each kind of loss.
This article cannot cover all the complexity of tax credits and deductions, or take into account each individual taxpayer’s specific situation. The only way to best take advantage of all credits and deductions allowed by law, without making any appropriate claims, is to consult with a tax professional.
Original content by clergyfinancial.com. This information is provided with the understanding that Payroll Partners is not rendering legal, human resources, or other professional advice or service. Professional advice on specific issues should be sought from a lawyer, HR consultant or other professional.