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The Differences Between Tax Credit And Tax Deduction

July 28th, 2010

Tax Credit Vs Tax Deduction. Let us first find out what tax credit and tax deduction are first. In a nutshell, both tax deduction and tax credit have similar effects: basically, they reduce the amount of the tax owed to the IRS (Internal Revenue service.).But they do have many differences. These would include how they are calculated, the way they affect what is owed to the IRS, how they are reported, and lastly who are eligible.

How do tax credit and tax deduction reduce taxes?

The main difference between tax credit and tax deduction lies on how it reduces the amount of tax to be paid. Your taxes gets more reduction with a tax credit simply because it is directly subtracted from your taxes. This is what we commonly know a below the line items. There would be a lesser reduction on a tax deduction just because it affext only the tax payer’s gross taxable income. Items included in a tax deduction are called above the line.

Reporting and Calculation of Tax Credit And Tax Deduction.

A tax credit is a direct percentage of an expense. While a tax deduction is calculated within your taxable income. You calculate tax credit using a tax form like the Retirement Savings Contribution Credit. Here you will need to make use of the IRS Form 8880 for you to get to claim the credit. For deductions, like the student loan interest deduction, one would use a worksheet to calculate the amount of reduction that would be applied to one’s taxable income.

For reporting of both tax credit and tax deductions, an IRS Form 1040 is required. Tax deductions are reported under Schedule A. Tax credits reports need more specific tax credit forms. If you have different tax credits to report, then they should be filed under each corresponding forms. Unlike tax deductions where they all will be recorded in the Schedule A form.

Who are eligible for Tax Credits and Tax Deductions?

Be informed there are various kinds of tax credit. The eligibility for a person will depend on the tax credit stipulation.Take for example the tax credit for first time home buyers. Single individuals who are making less than $95000 a year or married couples who are earning less than $150000 a year are eligible for the $8000 dollar first time home buyer tax credit. For tax credits, there would always be a dollar limit on how much one can claim. This limit is usually based on one’s modified adjusted gross yearly income. In order to claim this credit you would need to fill up the IRS Form 8839, which is attached to the IRS Form 1040.

Tax deductions are more general. One gets deductions on expenses like accrued interest on loans or mortgages, education expenses, expenses accrued due to accidents, casualties, robbery and the like. Unlike tax credit, almost every tax payer is eligible for tax deductions specific to their financial situation. Another difference is that tax deductions is determinant of the tax you owe the government. While tax credits are generally government packages used for stimulus programs. As used in the example above, the $8000 first time home buyers is one of the programs of the government to help more people acquire their very own homes especially in times like now where so many people are facing foreclosure on their properties.