The article below is accurate for your 2018 taxes, the one that you file this year by the April 2019 tax deadline. It has been updated to reflect changes made by the Tax Cuts and Jobs Act of 2017.
“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 tax deductions and tax credits can save you a significant amount of money on your taxes, they work in significantly different ways.
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 tax 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 2018 standard deduction of $12,000, so your taxable income would now be $38,000.
What is a Tax Credit?
Unlike tax deductions, tax credits are subtracted from your tax liability (not taxable income). A common tax 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 in 2018. If you have a total federal income tax liability of $3,500, the Child Tax Credit for one child would reduce that tax liability to $1,500.
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 tax deduction and a $100 tax credit, you would most likely prefer to receive the credit. Unlike a tax deduction, a $100 tax credit reduces your tax dollar-for-dollar ($100). On the other hand, a tax 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 are in the 24% tax bracket in 2018, a $100 tax deduction reduces your taxes by $24. On the other hand, a $100 credit would reduce your taxes by $100.
Itemized Deductions 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 deduction 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. Common itemized deductions include:
- 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 itemized deductions, however. You can only benefit from itemized deductions to the extent they exceed your standard deduction ($12,000 if you are single and $24,000 if married filing jointly in 2018). 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 $24,000. Let’s further say the total of your itemized deductions is $25,000. Since your itemized deductions exceed your standard deduction by $1,000, 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 tax 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 taking the itemized deduction – you’d just take the standard. Under the new tax law, TurboTax estimates that about 90% of taxpayers will now take the standard deduction since the standard deduction almost doubled for taxpayers and because some itemized deductions were either reduced or eliminated. Last tax season, about 70% of taxpayers took the standard deduction.
Don’t worry about trying to figure out which tax 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 tax deductions and credits you are eligible for based on your answers. TurboTax will also choose the option (standard deduction or itemized deductions) that you are eligible for and which gives you the biggest tax refund.
If you still have questions, you can connect live via one-way video to a TurboTax Live CPA or Enrolled Agent with over 15 years experience to get your tax questions answered. A TurboTax Live CPA or Enrolled Agent can even review, sign and file your tax return.
When are you filing your taxes? Have you taken advantage of any tax deductions or credits yet?