What is a tax deduction?
A tax deduction is a way to reduce the amount of money you have to pay in taxes. It’s like a special discount that the government gives you when you spend money on certain things. When you spend money on tax deductible expenses, you subtract that amount from your total income, which makes your total income lower. And when your total income is lower, you pay less money in taxes.
Think of it like a discount on the taxes you owe. The more deductions you have, the less you have to pay in taxes. For example, if you make $100 and you spend $10 on a tax deductible purchase, you would only have to pay taxes on $90 instead of $100.
Also read: Tax Brackets And Federal Income Tax Rates
What is a tax credit?
A tax credit is a dollar-for-dollar reduction of the amount of tax you owe. It’s different from a tax deduction because a tax credit reduces your tax bill directly, while a tax deduction only reduces the amount of your income that’s subject to taxes.
Think of a tax credit as a special bonus from the government that helps you pay less in taxes. For example, if you owe $1,000 in taxes and you have a $200 tax credit, your tax bill would go down to $800.
Common tax deductions
The most common tax deductions include:
- State and local taxes: You can deduct state and local income, sales, and property taxes on your federal tax return.
- Mortgage interest: If you own a home, you can deduct the interest you pay on your mortgage.
- Charitable contributions: Donations to qualified charitable organizations are deductible.
- Medical and dental expenses: You can deduct certain medical and dental expenses if they exceed a certain percentage of your adjusted gross income.
- Retirement plan contributions: Contributions to a pre-tax retirement account are deducted from your taxable income for the year.
- Education expenses: You may be able to deduct tuition and fees for yourself or a dependent for higher education expenses.
- Business expenses: If you’re self-employed, you can deduct a variety of business expenses including supplies, equipment, and home office expenses.
- Casualty and theft losses: If you have uninsured losses due to a natural disaster or theft, you may be able to deduct these losses.
- Job search expenses: If you’re looking for a job in your current line of work, you can deduct certain expenses, such as resume preparation and travel costs.
- Moving expenses: If you move for a new job, you may be able to deduct certain moving expenses, such as the cost of packing and shipping household goods.
Not everyone is eligible for all of these deductions and some may have restrictions or limits. Additionally, some deductions may be subject to phaseouts at higher income levels.
Common tax credits
The most common tax credits include:
- Child Tax Credit: The government will give you a credit of up to $2,000 per qualifying child under the age of 17.
- Earned Income Tax Credit (EITC): A credit for low-to-moderate-income working individuals and families.
- American Opportunity Tax Credit: A credit of up to $2,500 for education expenses for each eligible student in the first four years of higher education.
- Lifetime Learning Credit: A credit of up to $2,000 for education expenses for any level of post-secondary education.
- Child and Dependent Care Credit: A credit of up to $3,000 for expenses related to the care of a qualifying child under age 13 or a disabled spouse or dependent.
- Adoption Credit: A credit of up to $14,440 for qualified adoption expenses.
- Residential Energy-Efficient Property Credit: A credit for installing renewable energy systems, such as solar panels, wind turbines, and geothermal heat pumps, in your home.
- Foreign Tax Credit: A credit for taxes paid to a foreign country.
- Credit for the Elderly or the Disabled: A credit for individuals who are 65 or older or who are retired on permanent and total disability.
- Nonbusiness Energy Property Credit: A credit for making energy-efficient improvements to your home, such as adding insulation or replacing windows.
How to claim tax deductions and credits
The steps to claim a deduction or credit can vary depending on the type. For most tax deductions, you can follow the steps below:
- Determine your eligibility: First, make sure that you’re eligible to claim the deductions you’re interested in. Some deductions have income limits, age restrictions, or other qualifications you’ll need to meet.
- Keep records: For deductions, keep records of your expenses, such as receipts, invoices, and cancelled checks, to support the deductions you claim on your tax return. For credits, keep records of any expenses or documentation related to the credits you’re claiming, such as receipts, invoices, or forms from the provider of the credit.
- Choose the right tax form: If you’re an employee, you’ll use Form 1040 to file your tax return. If you’re self-employed or have business expenses, you’ll use Schedule C or Schedule C-EZ.
- Complete the appropriate tax form: Fill out the tax form and include the deductions and credits that you’re claiming.
- Calculate your deductions: Depending on the type of deduction, you’ll either subtract the deduction from your taxable income or multiply the deduction by your tax rate to determine the amount of your deduction.
- Calculate your credits: The amount of your credit will depend on the type of credit and the information you provide on your tax return.
- File your tax return: Once you’re done everything, submit your tax return and any supporting documents to the IRS.
Also read: Important Tax Filing Deadlines To Remember