Tax Credits vs. Deductions: What’s the Difference?

While most people only really start thinking about their taxes in during “tax season,” there are some important concepts that, if understood, can help you take action throughout the year to reduce your annual tax burden. Specifically, earning tax credits and tax deductions by performing certain actions can help cut your taxes significantly. Understanding the difference between tax credits and tax deductions is important for maximizing your savings.

What Are Tax Credits?

A tax credit is when an amount of money is removed from your tax bill, dollar for dollar. So, if you earn a $1,000 tax credit for installing solar panels on your home, your total tax bill for the year will be reduced by $1,000. When your accountant or tax attorney is completing your taxes, they will determine how much you owe for the year, and then submit the necessary documentation to have it reduced by the full $1,000.

What Are Tax Deductions?

A tax deduction, on the other hand, does not reduce your tax bill, but rather reduces your taxable income. If you make $100,000 per year, with no tax deductions at all, you will need to pay the full amount based on $100,000 of taxable income. If you invest $5,000 into a 401(k), which produces a $5,000 deduction, however, you will only end up paying taxes on $95,000. As far as the IRS is concerned, you will be taxed as if you were only making $95,000.

How to Earn Tax Credits & Deductions

Over the years, the government has passed many laws that will provide citizens opportunities for tax credits and deductions. The policy behind these things is to help encourage people to do things that the government believes is going to be good for the person, and for society as a whole. The list of ways to get tax credits and deductions is quite extensive, and virtually everyone will qualify for at least some of them.

Some things just occur naturally over the course of a lifetime, such as buying health insurance, saving for retirement, purchasing a home, and having children. Others require more intentional effort, such as installing solar panels on your home, donating to charities, and much more. Whether you’re intentionally seeking out ways to reduce your overall tax burden, or you just want to make sure you’re taking advantage of all the deductions and credits possible, it is a good idea to have a professional working on your behalf.

Contact Us

No matter your income level, having a tax attorney available to help determine what types of credits and deductions you qualify for can help you save hundreds, or even thousands of dollars every year. Contact E. Morgan Maxwell III to talk about your current tax situation, and how we can help.

Written by E. Morgan Maxwell

E. Morgan Maxwell

Since beginning his own firm, Mr. Maxwell has continued a tax-law oriented practice encompassing a wide range of transactions, planning and dispute resolution. His dispute resolution experience includes involvement at all levels of the Internal Revenue Service (Examinations, Appeals, Collections, Office of Professional Responsibility, the U.S. Tax Court), the Pennsylvania Department of Revenue, the Tax Litigation Section of the Pennsylvania Attorney General’s Office, Pennsylvania Commonwealth Court, Common Pleas Court and local taxing jurisdictions in southeastern Pennsylvania.

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