“Just write it off.”
“Go ahead and deduct it.”
“I think there’s a tax credit for that.”
Although you might have heard or even uttered one of the sentences above, have you ever wondered what it actually means? While both deductions and credits can save you a significant amount of money on your taxes, they work in significantly different ways.
For answers to this question and anything else related to your tax situation, TurboTax Live tax experts are available in English and Spanish, year round, and can even review, sign, and file your tax return or you can fully hand your taxes over to them.
See below for more about tax deductions and credits.
What is a Tax Deduction?
A tax deduction is a result of a tax-deductible expense or exemption which reduces your taxable income. A common deduction on your federal income tax return is the standard deduction. An example of how this works: If your income was $50,000, your standard deduction (if single or married filing separately) would reduce your taxable income by the 2020 standard deduction of $12,400, so your taxable income would now be $37,600.
What is a Tax Credit?
Unlike tax deductions, tax credits are subtracted from the taxes you owe (not taxable income). A common credit is the Child Tax Credit. If you have a qualifying child, you can take a credit of up to $2,000 per child against the taxes you owe for tax year 2020. If you have a total federal income tax liability of $3,500, the Child Tax Credit for one child would reduce what you owe down to $1,500.
Under the American Rescue Plan, beginning in tax year 2021 (the taxes you file in 2022) the Child Tax Credit will be expanded. The bill increases the amount that families claiming the Child Tax Credit receive from $2,000 to $3,600 for each child under 6 and $3,000 for each child age 6-17 depending on their income.
Is a Tax Deduction Better Than a Tax Credit? Is a Tax Credit Better Than a Tax Deduction?
If you were ever faced with a hypothetical choice between a $100 deduction and a $100 credit, you would most likely prefer to receive the credit. Unlike a deduction, a $100 credit reduces your tax dollar-for-dollar ($100). On the other hand, a deduction reduces your taxable income by $100. The resulting amount of tax you save depends on your marginal tax bracket (in everyday language: your tax bracket). If you were in the 24% tax bracket for tax year 2020, a $100 deduction reduces your taxes by $24. On the other hand, a $100 credit would reduce your taxes by $100.
Itemized vs. Standard Deductions
Just about everyone qualifies for the standard deduction. Although the amount varies depending on your filing status (e.g., single, married filing jointly, married filing separately, or head of household), all people with the same filing status receive the same standard amount (the only exceptions are for the elderly, disabled, or blind – they receive a somewhat higher standard deduction).
By contrast, itemized deductions are numerous and their amounts vary by individual and the deductions they are eligible. People commonly itemize:
- Certain medical and dental expenses above 7.5% of your adjusted gross income
- State income taxes
- State sales and local tax
- Property taxes
- Charitable contributions
- Mortgage interest
There’s a bit of a hitch with being eligible for itemized deductions, however. You can only benefit to the extent they exceed your standard deduction ($12,400 if you are single and $24,800 if married filing jointly for tax year 2020). Said another way, each taxpayer is permitted to take the higher of their standard or itemized deductions – but not both.
Say you are married and filing jointly. In such a case, your standard deduction is $24,800. Let’s further say the total of your itemized deductions is $26,000. Since your itemized deductions exceed your standard deduction by $1,200, you would most likely prefer to take the itemized deduction. That’s why it pays to keep track of additional tax-deductible expenses that may bump you up over the standard deduction and leave you open to additional deductions, like charitable contributions.
On the other hand, if your itemized deductions totaled any amount less than the standard deduction you qualify for, you likely wouldn’t bother itemizing – you’d just take the standard deduction. Under tax reform, TurboTax estimated and the IRS confirmed that about 90% of taxpayers now take the standard deduction since it has almost doubled for taxpayers and because some itemized deductions were either reduced or eliminated. Prior to tax reform, about 70% of taxpayers claimed the standard deduction.
We’ve Got You Covered
Don’t worry about trying to figure out which credits or deductions you should take, or if you should itemize or take the standard deduction. TurboTax will ask you simple questions about you and give you the deductions and credits you are eligible for based on your answers. TurboTax will also choose the option (standard versus itemized deductions) that you are eligible for and which gives you the biggest refund.
If you still have questions, you can connect live via one-way video to a TurboTax Live tax expert with an average of 12 years of experience to get your questions answered or new this year, you can fully hand your taxes over to them from the comfort of your home with TurboTax Live Full Service. TurboTax Live tax experts are available in English and Spanish, year round, and can even review, sign and file your tax return.
When are you filing your taxes? Have you taken advantage of any deductions or credits yet?