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Tax Deduction vs Tax Credit: What’s the Difference?

Updated: Feb 17

No matter if you’re an ATBS client or you’ve been using another tax professional, you’ve probably heard the terms tax credit and tax deduction. But do you know the difference between the two?

Both are going to save you a significant amount of money when it’s time to file your taxes, but they operate in very different ways. Keep reading as we dig into a tax deduction vs. a tax credit.

What is a tax deduction?

A tax deduction happens when you have a tax deductible expense or an exemption. This reduces your overall tax liability. As an owner-operator truck driver, you have numerous tax deductions for your business including your truck payment, fuel expenses, accounting and bookkeeping fees, and more.

In the past, one of the most common exemptions taxpayers could deduct from their income taxes was the personal exemption. However, starting with tax year 2018 this is being eliminated due to the Tax Cuts and Jobs Act.

Here is an example to help you understand how tax deductions work. Let’s assume your income is $75,000, you own a home which has property taxes of $4,500 per year. Because property taxes are an income tax deduction, your taxable income would now be $70,500.

What is a tax credit?

Tax credits work very different than tax deductions. Tax credits will reduce your tax liability instead of reducing taxable income. One of the most important tax credits for parents is the child tax credit. Starting with tax year 2018, the child tax credit will give parents a $2,000 tax credit for each child dependent.

To show you how a tax credit differs from tax deductions, consider the following example. Let’s assume you have a tax liability of $5,000 and you have two children. The two children would allow you to receive a $4,000 tax credit. This would decrease your tax liability to $1,000.

Standard Deductions vs Itemized Deductions: Which should you take?

When filing your income tax return, you have the option to use either a standard deduction or itemized deduction. Starting with tax year 2018, the standard deduction will be drastically increasing to $24,000 from $12,700 for married filing jointly and to $12,000 from $6,350 for single filers.

Alternatively, if you have enough deductible expenses in any single tax year, you can choose to itemize your deductions. However, now that the standard deduction has been increase by nearly 100%, the number of people itemizing should be significantly less.

Some common itemized deductions include the following:

● Mortgage interest ($750,000 limit)

● Property taxes (up to $10,000 starting with tax year 2018)

● Medical and dental expenses (when expenses exceed 7.5% of adjusted gross income)

Let’s assume you have personal deductions totaling $13,000 and you file your taxes married filing jointly. Because this is significantly less than the standard deduction of $24,000, it would make more sense to file your return using the standard deduction. However, if your itemized deductions are greater than the standard deduction, it would make sense to file with itemized deductions.

No matter if you’re filing your return with tax deductions, tax credits or both, you’re going to want to apply the maximum allowed. Both are going to reduce your taxable income and both are going to help keep more of your hard earned money in your pocket.

If you have any questions about how tax credits and tax deductions affect your tax situation, feel free to reach out to a tax professional at ATBS by calling 866-920-2827.

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