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Taxes are an issue that most never like to think about – except when there is way to pay less; fortunately, a tax credit enables you to just that. Tax credits are reductions of the actual tax owed by a business or individual taxpayer, and in most cases: significantly reduce the amount owed to the Federal government. Federal tax credits are normally approved by Congress and implemented and managed by the Internal Revenue Service (IRS).
Tax Credit vs. Tax Deduction
A tax credit reduces the actual amount of tax that is owed, and must be paid, to the IRS; on the other hand, a tax deduction only reduces the amount of taxable income. Tax deduction affects on the amount of tax owed are dependent on the variations in the progressive tax rate; however, a tax credit is not. Tax credits are of equal value (in terms of reducing the amount of tax owed) for all taxpayers – regardless of income level. Therefore, tax credits are widely regarded as much more valuable than tax deductions.
To clarify the difference between tax credits and tax deductions, let’s take a look at an example:
A $1000 tax credit vs. $1000 tax deduction:
For this example, imagine that there are two events, or items, that have a tax benefit value of $1000: the first is a tax deduction, and the second – a tax credit.
If an event causes a legal and valid tax deduction, it will serve to reduce the taxpayers taxable income by $1000. Tax rates vary according to individual taxpayer’s gross annual income – the more a taxpayer earns, the higher the rate as a percentage. Therefore, the amount that the deduction reduces taxable income will vary. For the purposes of this example, we will use a tax rate of 25%. For taxpayers in this tax rate bracket, the $1000 tax deduction would result in an actual tax savings of $250 ($1000 x .25 = $250). Taxpayers in a lower tax rate bracket would save, and those in a higher rate bracket – more.
On the other hand, a tax credit event with same $1000 value would result in a tax savings of $1000 for all taxpayers eligible to claim the tax credit – regardless of the taxpayer’s tax rate percentage bracket.
Types of Tax Credits
There are hundreds of tax credits authorized by Congress and managed by the IRS, and the ones individual taxpayer’s are eligible for varies. Some tax credits are used to encourage certain activities such as: using alternative energy sources or driving cars that produce fewer carbon based emissions. Still, other tax credits are designed to provide tax relief to lower and middle income families and taxpayers. There are tax credits designed to assist businesses as well as individuals – provided the business or individual is eligible to claim a certain credit.
One of the most commonly claimed tax credits is the Earned Income Tax Credit. This tax credit was created to offer assistance to low income workers, and help them create more of their earnings. This encourages people to accept jobs at lower wages that even pay only the minimum wage by significantly reducing their tax liability, and enabling them to have a higher “take home” pay. The Earned Income Tax Credit can actually be claimed at any time, and the credit is given to the taxpayer each pay period. Thus, the low income worker does not have to wait until he/she files a tax return to receive the benefits of the tax credit; the credit is applied whenever he/she receives a paycheck – this results in little or no federal income taxes being withheld.
Other types of tax credits are used to encourage activities that benefit everyone in our society. Tax credits given to businesses that help provide environmental improvement changes are an example. Congress legislates tax credits for many varied activities and events, which are deemed to help society in general. Congress uses tax credits as a reward for certain activities that benefit the general public, and they serve as an incentive toward these types of activities.
Tax credits are often misunderstood by taxpayers, and many are not aware of tax credits that they may be eligible for. When filing your income tax returns, it is important to understand the distinction between tax credits and tax deductions. On a dollar for dollar basis, a tax credit will almost always provide more tax savings. Most taxpayers are eligible for one tax credit or another; therefore, you should research into which tax credits may be available for you.
Tax Credit vs. Tax Deduction
A tax credit reduces the actual amount of tax that is owed, and must be paid, to the IRS; on the other hand, a tax deduction only reduces the amount of taxable income. Tax deduction affects on the amount of tax owed are dependent on the variations in the progressive tax rate; however, a tax credit is not. Tax credits are of equal value (in terms of reducing the amount of tax owed) for all taxpayers – regardless of income level. Therefore, tax credits are widely regarded as much more valuable than tax deductions.
To clarify the difference between tax credits and tax deductions, let’s take a look at an example:
A $1000 tax credit vs. $1000 tax deduction:
For this example, imagine that there are two events, or items, that have a tax benefit value of $1000: the first is a tax deduction, and the second – a tax credit.
If an event causes a legal and valid tax deduction, it will serve to reduce the taxpayers taxable income by $1000. Tax rates vary according to individual taxpayer’s gross annual income – the more a taxpayer earns, the higher the rate as a percentage. Therefore, the amount that the deduction reduces taxable income will vary. For the purposes of this example, we will use a tax rate of 25%. For taxpayers in this tax rate bracket, the $1000 tax deduction would result in an actual tax savings of $250 ($1000 x .25 = $250). Taxpayers in a lower tax rate bracket would save, and those in a higher rate bracket – more.
On the other hand, a tax credit event with same $1000 value would result in a tax savings of $1000 for all taxpayers eligible to claim the tax credit – regardless of the taxpayer’s tax rate percentage bracket.
Types of Tax Credits
There are hundreds of tax credits authorized by Congress and managed by the IRS, and the ones individual taxpayer’s are eligible for varies. Some tax credits are used to encourage certain activities such as: using alternative energy sources or driving cars that produce fewer carbon based emissions. Still, other tax credits are designed to provide tax relief to lower and middle income families and taxpayers. There are tax credits designed to assist businesses as well as individuals – provided the business or individual is eligible to claim a certain credit.
One of the most commonly claimed tax credits is the Earned Income Tax Credit. This tax credit was created to offer assistance to low income workers, and help them create more of their earnings. This encourages people to accept jobs at lower wages that even pay only the minimum wage by significantly reducing their tax liability, and enabling them to have a higher “take home” pay. The Earned Income Tax Credit can actually be claimed at any time, and the credit is given to the taxpayer each pay period. Thus, the low income worker does not have to wait until he/she files a tax return to receive the benefits of the tax credit; the credit is applied whenever he/she receives a paycheck – this results in little or no federal income taxes being withheld.
Other types of tax credits are used to encourage activities that benefit everyone in our society. Tax credits given to businesses that help provide environmental improvement changes are an example. Congress legislates tax credits for many varied activities and events, which are deemed to help society in general. Congress uses tax credits as a reward for certain activities that benefit the general public, and they serve as an incentive toward these types of activities.
Tax credits are often misunderstood by taxpayers, and many are not aware of tax credits that they may be eligible for. When filing your income tax returns, it is important to understand the distinction between tax credits and tax deductions. On a dollar for dollar basis, a tax credit will almost always provide more tax savings. Most taxpayers are eligible for one tax credit or another; therefore, you should research into which tax credits may be available for you.
