HomeFinanceTax Credit and Tax Deduction; Essential Differences

Tax Credit and Tax Deduction; Essential Differences

As the financial year comes towards an end, it will be vital that you should understand how you need to file your income tax properly so that you may claim all your tax credits and deductions. There are a lot of people who are not aware of the difference between the two and this may cause them to pay up hundreds and even thousands of dollars in the form of unclaimed refunds. This small article will help you understand the essential difference between the two.

What are the main differences?

main Differences

 The main difference between the two is basically quite simple. The tax credit is going to reduce the amount that you have as a tax liability. The tax deduction will reduce your amount of taxable income. In the end, both of these will be reducing the amount of taxes that you need to pay. This means that theoretically, you will be able to save a lot of money. But the manner in which these are calculated remains quite different.

What is the mode of calculation?

calculate sales taxes

Suppose, for instance, that in a particular financial year you had made $ 50000 and there were no tax credits or deductions. In this case, your rate of income tax is 22% and your tax liability will come to about $6000. The tax credit will reduce this $ 6000 while the tax deduction is going to reduce the $ 50000. After this, you can easily calculate the amount that you owe.

Other differences that exist

taxes

The most influential difference will lie in the manner in which your tax credit and tax deductions affect your own income tax return. A tax deduction can easily lower the tax bracket that you are in. As a single filer, the standard deduction is $ 12000 and this has a cutoff within the 12% tax bracket while the 22 % tax bracket is at $ 39000. IF you stick with the previous example, then the standard deduction can reduce the taxable income that you have to $ 37000 from $50000. Thus, your taxable income is lower and below the $ 39000 mark. Thus, you can be taxed at a lower interest rate of 12 % instead of the 22 %. Your tax liability in this case will be around $ 4000.

Understanding Tax credits

tax-credits

The tax credit is basically a reduction in your tax liabilities. Instead of having to lower your taxable income and then recalculating, if you have to pay $ 100 and you have a $ 100 credit then you shall owe $ 0. The credits may either be refundable or completely non refundable. The refundable credits can lower your owed amount to even $ 0 and then provide you with a refund of the difference in case there are leftover credits that are available.

It is also important to learn that there are several types of different credits and deductions which you may claim. You will need to research on all of these and then figure out the ones that you qualify for but this is an extremely tedious and difficult job. However, it can help you understand how different credits and tax deductions may affect your tax returns. You may miss out on essential credits and tax deductions in case you are not careful. This means you will risk losing out on saving a lot of money.

You may consider using an online Income Tax Return Calculator to help you calculate your income tax amounts. You may also consider hiring professional tax advisors to help you sort your tax credits and tax deductions. You can find several highly trained tax advisors on the internet who are aware of all the tax laws, tax credits and deductions.

Conclusion

In conclusion, calculating income taxes can be very tiresome and there are severe chances of committing mistakes. You will have to look after your tax credits, tax deductions, various income sources and so on. A mistake in any of these fields can result in severe financial and legal troubles. Hence, it is vital that you should look for guidance while filing your tax returns and hire a professional tax consultant. Hopefully, the information mentioned in this article will help you.

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