Do You Know the Difference Between a Tax Deduction and a Tax Credit?

As the New Year kicks off, it’s a good time to start thinking about tax planning. Knowing the difference between tax deductions and tax credits is key to making your taxes work for you and boosting your family’s wealth.

**Tax Deduction**

Tax deductions are basically items that reduce your taxable income. They’re subtracted from your total income to adjust it. There are two main types. “Above the line” deductions are calculated on the first part of your Form 1040 to create your adjusted gross income. The second type is found on the latter part of Form 1040, including the standard deduction or Schedule A deductions. These help further reduce your income to determine your taxable income.

**Tax Credit**

Unlike deductions, a tax credit directly decreases the amount of tax you owe. Once you’ve figured out your taxable income, you use tax tables to find out your tax amount. Then, you apply tax credits to cut down the total. Tax credits work like a gift card against your tax bill: if credits are more than what you owe, you might even get a refund from the government.

Tax credits generally offer more value than deductions since they reduce the tax bill dollar for dollar instead of just lowering taxable income.

**Tax Advantages**

To get the most out of tax deductions and credits, keep track of eligible expenses throughout the year. Make sure to save all receipts and documents to back up your claims if needed. As we move into 2021, use tax credits and deductions as part of your financial planning so you can take full advantage without rushing at the year’s end.

For wise decision-making, think about talking to a professional tax advisor.