Differences Between Tax Deductions and Credits

Claiming the appropriate deductions and credits will impact your tax return

Understanding the difference between deductions and credits is crucial for effective tax planning. While they are often discussed together, they serve distinct purposes. A deduction reduces your income subject to tax, while a credit directly reduces the tax you owe.

The Basics of Deductions and Credits

Deductions: A deduction lowers your taxable income. For example, if you are a single filer with $11,000 of taxable income, the federal income tax due on that income in 2024 would be $1,100 (10% of $11,000). A $1,000 deduction would reduce your taxable income to $10,000 ($11,000 – $1,000), resulting in a tax due of $1,000 (10% of $10,000). This yields a tax savings of $100.

Credits: A credit reduces the amount of tax you owe. Using the same example, if you have a $1,000 credit instead of a deduction, your federal income tax due would decrease to $100 ($1,100 – $1,000), resulting in a tax savings of $1,000.

Because credits directly reduce your tax liability, they are typically more valuable than deductions.

The Importance of Deductions
Despite credits generally offering more significant tax savings, deductions are still highly beneficial. They come in various forms and are scattered throughout your tax return. The most commonly recognized deductions are itemized deductions, which include:

•Medical Expenses: Costs for medical care that exceed a certain percentage of your income.
•State and Local Taxes (SALT): Includes state and local income, sales, and property taxes.
•Home Mortgage Interest: Interest paid on a qualified home loan.
•Charitable Contributions: Donations made to qualified charitable organizations.

How to Claim Deductions
To claim itemized deductions, you must itemize them on your tax return. This means listing each deduction separately, typically on Schedule A, if the total exceeds the standard deduction for your filing status.

Standard Deduction for 2024
For the 2024 tax year, the standard deduction amounts are as follows:

•Individuals and Married Couples Filing Separately: $14,600
•Married Couples Filing Jointly: $29,200
•Heads of Household: $21,900

Additionally, there is an extra standard deduction for the elderly or blind, which is $1,550 per person. For a qualifying couple, this amounts to $3,100 ($1,950 for unmarried taxpayers).

Your Advisor Can Help
While both deductions and credits can reduce your tax liability, they do so in different ways. Deductions lower your taxable income, while credits directly reduce the tax you owe. Understanding these differences and knowing how to claim the appropriate deductions and credits can significantly impact your tax return. Always consider consulting your financial advisor and tax professional to maximize your tax benefits and ensure compliance with tax laws.

To learn more, schedule a meeting with one of our financial professionals today.

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