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While using tax preparation software or even better, a professional tax preparer can ease the burden of preparing your annual taxes, there’s still some work you’ll have to do on your end.
The silver lining of filing a tax return is the potential promise of a refund. And one of the best ways to land yourself in refund territory is by maximizing tax credits and tax deductions. Both are useful strategies to reduce what you owe (or even better , increase what Uncle Sam owes you), but the two are different.
So what’s the difference between a tax credit and a tax deduction — and which is better?
Definitions: Tax Credits and Tax Deductions
Tax credits have a more direct impact on what you owe, dollar for dollar. It is a direct reduction in your total tax bill. For example, if you owe the government $5,000 and you have a tax credit of $2,000, you instead only owe $3,000.
Tax deductions reduce the total amount of your income that is subject to taxation. Deductions used to be more attractive until the federal government raised the standard deduction in 2017 and also removed many itemized deductions.
According to the Urban-Brookings Tax Policy Center, 90% of Americans take the standard deduction rather than itemized, because their deductions don’t exceed the allowable threshold.
While both strategies can impact how much you owe or are owed, tax credits typically yield larger savings especially since the 2017 tax reform. A knowledgeable tax professional (or a paid tax preparation software) will be able to combine the two strategies to get your tax bill as low as possible or, better yet, increase the value of your refund.
How Tax Credits Work
If you qualify for a tax credit, you can apply it to your overall tax bill, reducing what you owe dollar for dollar. Because these have a larger impact and reduce what the federal government can earn from taxpayers, the rules surrounding these are more stringent , and the credits are much more challenging to…
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