TAX DEDUCTIONS & CREDITS: KNOWING THE DIFFERENCE

Posted by at 10:49 am 62 Comments Print

This may seem obvious to some but there is much confusion over the difference between a tax “deduction” and a tax “credit”. A tax deduction gets subtracted from your taxable income, which in turn lowers your taxable income, which lowers your taxes.

For example, if you have $50,000 income and a $5,000 deduction, your taxable income is $45,000.  So you are not going to pay tax on $5,000 of your income.  In a 30% tax bracket you would save $1,500 (which is 15% of $5,000) Now, let’s take the same example but this time with a $5,000 tax credit.  The income tax on $50,000 would be $15,000 (in a 30% tax bracket).   With a $5,000 tax “credit”, you would subtract that $5,000 from your $15,000 tax bill and pay only $10,000 in taxes. Obviously, a tax credit is more beneficial than a deduction.

 

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