Tax Credits or Deductions

During this tax season, it can pay to understand the two types of tax breaks the IRS offers. The first includes tax deductions, which reduce your taxable income before determining your tax bill. The second is a tax credit, which reduces any taxes you owe. Both can help reduce your 2019 tax bill, whether you file as an individual, a business or both.

THE DIFFERENCE

The most valuable tax break is a credit, which reduces your taxes dollar for dollar. Let’s say you qualify for $2,000 with the American Opportunity Credit, a credit for certain education costs, and you initially owe $4,000 in federal income tax. Subtract the credit from your taxes owed dollar for dollar and you’ll halve your tax bill, saving $2,000.

On the other hand, you would subtract a $2,000 student loan interest deduction, which some taxpayers get for qualified education expenses, from your taxable income, not taxes owed. If your effective tax rate is about 20%, this deduction will cut your tax bill by $400.

You’ll have to choose between taking deductions and taking the standard deduction. You generally can’t take both. You can, however, take some tax credits along with the standard deduction. Your tax professional can ensure you get the most from any tax breaks available to you.

TYPES OF BREAKS

By working with a tax pro, individual taxpayers may learn if they qualify for tax credits, including earned income, child and dependent care, health coverage, adoption and others. Deductions might include capital losses and work-related education expenses. Contributions made to IRAs, Health Savings Accounts and 401(k) plans may also be deductible.

Businesses also have their fair share of credits and deductions. Energy-efficient manufacturing equipment, business-owned electric vehicles and certain types of research may net you tax credits. Tax deductions could include capital improvements, everyday business expenses and interest paid on business loans.