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Tax credits and deductions are different ways to reduce the total tax paid. Deductions reduce taxable income, while credits are taken after tax is calculated. Tax credits can reduce the amount owed or result in a refund, but are subject to limits. It’s important to keep up with current tax laws to see if there are any special credits available.
It is important to understand the distinctions between a tax credit and a tax deduction, as they are two different ways to reduce the total tax you will pay. When you start to decide how much to pay in taxes, you are allowed certain deductions, such as those for each child or dependent. These deductions reduce the amount of your income that is considered taxable.
Rather, the tax credit is taken after you’ve decided how much of your income is taxable and figured out how much tax you actually owe. When you can take certain tax credits, such as those offered to buy a hybrid vehicle, you deduct this amount directly from the taxes you owe. If you owe $2,500 in tax and have a tax credit of $2,000, subtract that credit directly from $2,500, reducing the total tax owed to $500. The amount of tax you have paid during the year is also part of your tax credit. This amount is deducted from the total you still owe, or it may reduce your tax liability to zero. In some cases, tax credits can mean that the government owes you money, although with very few exceptions, this money cannot exceed the amount you paid in taxes for the year.
One exception to the tax credit is the Earned Income Credit available to very low-income families. In this case, the amount of Earned Income Credit you earn may actually exceed the amount of taxes you paid, so you can get the money back as some sort of aid or assistance. This is a method of helping families who are having financial difficulties, although the amount given to you may be relatively small.
Another more common credit that many people in the United States take today is the Child Tax Credit. This is different than the standard deduction you take for caring for a dependent child. The amount is deducted directly from your tax, dollar for dollar, instead of your income, while the child care deduction reduces your total taxable income and may put you in a lower tax bracket.
It’s a good idea to be aware of tax credits that may only appear for one year. In 2006, for example, tax returns, US citizens could claim a one-time telephone tax credit due to overpayment of taxes on telephone services. This was offered for one year only, and those who missed it, just missed it. They were not compensated by the government for this credit unless they specifically claimed it.
Many people suggest that the tax credit is more valuable than the tax deduction because it directly reduces the amount of tax you must pay. In reality, both tax deductions and tax credits are important, as both can be a means of reducing your taxes. Tax credits tend to be more straightforward, and you should keep abreast of current tax laws to see if there are any special credits you might qualify for in each given tax year.
Smart Asset.
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