The Difference Between Tax Credits and Tax Deductions: Which One Can Get You a Bigger Refund?
Figuring out your income taxes can be a daunting task. There are so many different rules and regulations to remember, and it can be difficult to understand what you can deduct and what credits you are eligible for. In this article, we will take a closer look at tax credits and tax deductions to help you determine which one can get you a bigger refund.
Tax credits and tax deductions are two of the most common ways that taxpayers can reduce their tax liability. However, they work differently and have different eligibility requirements.
Tax Deductions
Tax deductions are expenses that you can deduct from your taxable income, which will reduce the amount of tax you owe. There are two types of tax deductions: standard and itemized.
Standard deductions are set by the IRS each year and are based on your filing status. For the tax year 2021, the standard deductions are:
- $12,550 for single filers
- $25,100 for married couples filing jointly
- $18,800 for head of household
If you choose to take the standard deduction, you do not need to itemize your deductions. However, if your itemized deductions are higher than the standard deduction, you may want to consider itemizing your deductions.
Itemized deductions are specific expenses that you can deduct from your taxable income, such as mortgage interest, state and local taxes, medical expenses, and charitable donations. To take advantage of itemized deductions, you must keep track of all your deductible expenses throughout the year and report them on Schedule A.
It's important to note that not all expenses can be itemized. For example, you cannot deduct expenses you incurred for your personal use or expenses related to your job that your employer reimbursed you for.
Tax Credits
Tax credits are a dollar-for-dollar reduction in your tax liability. If you owe $5,000 in taxes and are eligible for a $2,000 tax credit, you will only owe $3,000 in taxes.
There are two types of tax credits: refundable and non-refundable. Refundable tax credits can be used to reduce your tax liability to zero, and any excess amount will be refunded to you. On the other hand, non-refundable tax credits can only be used to reduce your tax liability to zero, and any excess amount cannot be refunded to you.
Some common tax credits include:
- Child Tax Credit
- Earned Income Tax Credit
- American Opportunity Tax Credit
- Lifetime Learning Credit
- Saver's Credit
Which One Can Get You a Bigger Refund?
Now that we have a better understanding of tax credits and tax deductions, let's look at which one can get you a bigger refund.
Tax credits are generally more beneficial than tax deductions because they directly reduce your tax liability. For example, if you owe $5,000 in taxes and are eligible for a $2,000 tax credit, you will only owe $3,000 in taxes. However, if you are eligible for a $2,000 tax deduction, your taxable income will be reduced by $2,000, but you will still owe taxes on the remaining amount.
That being said, it's important to consider both tax credits and tax deductions when filing your taxes. If you are not eligible for many tax credits, you may want to consider itemizing your deductions to reduce your tax liability.
Conclusion
Understanding the difference between tax credits and tax deductions can be confusing, but it's important to know the difference to maximize your tax refund. While tax credits are generally more beneficial, it's important to consider both tax credits and tax deductions when filing your taxes. Keep track of all of your expenses and speak with a tax professional if you have questions or need help navigating the tax code.