7 Days of TaxMas Tax Tips!

Day 2: Understanding the difference between a Tax Credit and a Tax Deduction

Welcome to Day 2 of our 7 Days of TaxMas Tax Tips! Today our topic of discussion is all about understanding the difference between a Tax Credit and a Tax Deduction. The reason understanding the difference between these two things is because they can both make a big difference in your taxable income (amount of income that is actually taxed) and your tax liability (tax bill).

What is a Tax Liability?

Your Tax liability is the technical term for how much money you owe in taxes. Your Tax liability is based on a multitude of factors such as your tax bracket, tax credits applicable to you, tax deductions, and filing status. Now, we will elaborate more on this during our 7 Days of Tax Tips so stay Tuned!

Tax Credits

Tax Credits are a dollar-for-dollar amount taxpayers can claim on their tax return to reduce the income tax they owe. Tax Credits are created throughout and then applied to your tax return at year end to reduce your tax liability. The great thing about Tax Credits is that although they reduce your tax liability they do not reduce your taxable income.

There are refundable tax credits and then there are nonrefundable tax credits. Refundable tax credits can reduce your tax liability AND create a tax refund for you. Whereas nonrefundable tax credits can reduce your tax liability but WILL NOT create a tax refund for you.

For example: When you create a baby and have that baby, the child that you just birth creates a tax credit that you can claim come year end. This is also known as the Child Tax Credit or via the (Additional Child Tax Credit). The CTC is a nonrefundable tax credit and the ACTC is the refundable portion of the Child tax credit.

What is a Tax Refund?

A tax refund is the amount of money that is potentially owed to you due to either an overpayment of taxes throughout the year or due to tax credits created throughout the year.

Tax Deductions

Tax deductions are an item or expense that a taxpayer can claim to reduce that taxpayer’s income or tax liability. Tax deductions are NOT dollar for dollar. Just like Tax Credits, tax deductions are created throughout the year by your expenses and items purchased and then they are applied to your tax return at year end. When you apply tax deductions to your taxes although they reduce your tax liability, not dollar for dollar, they also reduce your taxable income.

For example: If my initial taxable income is $100,000 and I have deductions that equal $20,000. My deductions are going to lower my taxable income to $80,000 in which my tax bill will be calculated based on the $80,000 instead of the $100,000. This is how my tax liability will be reduced AND my taxable income is decreased.

You have to be careful with tax deductions especially when you are looking to make large purchases in the next 2-3 years as they can have a great impact on the amount of funding you are allotted.

Check out our previous email for a list of a few deductions that you can claim as a business owner.

Get Expert Assistance

Navigating the complexities of tax deductions can be overwhelming. At Xtreme Financial Group, our team of tax specialists is here to help. We can guide you through the process, identify all eligible deductions, and ensure you take full advantage of tax-saving opportunities.

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