Tax Credit Vs Tax Deduction

Tax Credit Vs Tax Deduction. Before we touch on their differences, let us discuss about what they actually are. 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. They differ in the way they are calculated, the affect on the over all tax payable, filing and reporting, and the eligibility of the tax payers.

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. Tax deduction on the other hand has a lesser effect on reducing your tax payable since it only affects your gross taxable income. Tax deduction is also known as an "above-the-line" item.
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. Tax forms such as Retirement Savings Contribution are used for tax credit. And to claim your tax credit, an IRS Form 8880 is needed. Documents in the form of worksheets are used to calculate tax deduction and the amount would be subtracted from your taxable income.

For reporting of both tax credit and tax deductions, an IRS Form 1040 is required. You would file deductions within Schedule A while tax credits will be reported under more specific tax credit forms. Different kinds of tax credits will have to be filed under different forms. Unlike tax deductions where they all will be recorded in the Schedule A form.

Who qualifies for tax credits or tax deductions?

There are different kinds of tax credits. The eligibility for a person will depend on the tax credit stipulation. A good example would be the first time home buyer tax credit. 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. And to claim the refund, the IRS form 8839 is required.

Tax deductions are more general. They usually cover standard expenses such as interests on debt or mortgages, accidents, casualty, loss incurred due to theft, expenses on education and many more. Unlike tax credit, almost every tax payer is eligible for tax deductions specific to their financial situation. Tax deductions are used to determine taxable income. 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.