You are probably familiar with terms like tax deductions and tax credits, but did you know there is a big difference between the two? Both deductions and credits reduce how much tax you pay, but how both impact your taxes is quite different.
A deduction is something that reduces your overall taxable income, therefore lowering your tax bill. A credit is different because it reduces your tax liability, dollar for dollar.
To get a better idea of how significant this is, let’s look at an example. If you were able to take a $1,000 deduction that would mean you would reduce your taxable income by $1,000. So if your taxable income was $40,000, after the deduction it would mean your taxable income would become $39,000. At the 25 percent tax rate, that would effectively lower your tax bill by $250.
Now, let’s say you are entitled to a $1,000 tax credit. In this case, you would simply reduce your tax bill by the full $1,000! As you can see, this is why tax credits are the most sought after.
So, what kind of tax credits are available to you come tax time? Well, here are a few common ones that are worth double checking each year to see if you qualify.
Child and Dependent Care Credits
The most common tax credits have to do with children and there are two main credits. First is the child tax credit, which gives you a credit for qualifying children you take care of. The credit is $1,000 per qualifying child, and you must meet income requirements.
In addition to the child tax credit there is also a credit for child care expenses. Depending on your situation there are many qualifiers and limits to what can be claimed, but any time you have children these are credits worth looking into.
Finally, there is an adoption tax credit as well. This credit is meant to help ease the financial burden of going through the adoption process. This credit can be as high as $13,360 per child.
Elderly and Disabled Credit
Once you reach age 65, or if you are on permanent disability, there are a few tax credits available. Unfortunately, these credits have very low income limits, so they aren’t available to many.
Going green has its benefits beyond just helping the environment. There are tax credits available on anything from buying Energy Star appliances to a hybrid vehicle. These credits vary greatly depending on what you buy, but you can typically get up to a 10 percent credit of the purchase price on qualifying energy efficient appliances and home improvements, up to a maximum of $500. That’s not too bad if you need to replace an old appliance anyway.
Earned Income Tax Credit
Another popular tax credit for lower income filers is the earned income tax credit, or EITC. If you have earned income that falls below certain limits (based on how you file and family size) you may be entitled to this credit. Families with children really benefit from this credit and may receive a credit anywhere from a few thousand to over five thousand dollars.
Here is a tax credit that often gets overlooked. The saver’s credit helps low to moderate-income filers to save for retirement. This credit is worth up to $1,000 ($2,000 for married filing jointly) for those contributing to a qualifying retirement plan such as a 401k or IRA. As if the credit isn’t enough, keep in mind that contributions made to some retirement plans also count as tax deductions, so you’re basically double-dipping in the tax savings. It makes saving for retirement a no-brainer.
Make Sure You Get Your Credits
As you can see, there are a number of tax credits available, and these are just the most common ones. Some of these can be easy to overlook, and if you aren’t careful you could be leaving money on the table. Using your trusted TurboTax software, you can be sure you’re getting every tax deduction or credit you deserve.