What's the difference between a tax deduction and a tax credit? Good question. The way these two words are thrown around, many people think they’re synonyms. While both save you money on taxes, however, a $100 credit and a $100 deduction are not worth the same amount to you, says Lisa Greene-Lewis, CPA at TurboTax.
In the hierarchy of tax breaks, credits give you more bang for your buck than deductions, since a credit is a dollar-for-dollar reduction of the taxes you owe. So a $100 credit means you pay $100 less in taxes. The biggest categories for credits include children (and childcare), education and energy efficiency.
A deduction, on the other hand, reduces the adjusted gross income on which you are taxed. You calculate the worth of your deduction by multiplying your marginal (or top) tax rate by the amount of the deduction. So, if you're in the 25% tax bracket, a $100 deduction means you'll pay $25 less in taxes (0.25 times $100). Deductions don’t pack quite the same punch as credits, but there are more deductions available—and they do add up.
Deductions generally come in two varieties: There are so-called “above-the-line” deductions available even if you take the standard deduction ($6,200 for single people and $12,400 for married people in 2014, regardless of income) which anyone can take unless you’re subject to the AMT, says St. Louis CPA Douglas Mueller. These include student loan interest, contributions to your retirement account, and job-related moving expenses, to name a few. Other deductions are only available to those who itemize, rather than taking the standard deduction If you pay a lot in mortgage interest, state taxes or self-employment costs, among others, itemizing usually makes sense, says Mueller.
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