Tax deductions and tax credits are usually referred to like the same by most people. They can make a significant impact and cut down the tax bill significantly but in different ways. Learn the main differences— along with some of my favorite tips for saving money this tax season.
What is the difference between a tax credit and a tax deduction?
A tax deduction helps to lower the tax bill. It works by lowering the total amount of taxable income, thus reducing the total dollar amount you will have to pay for the year in question.
The formula works as follows: calculate total income, subtract each one of the deductions from the total, the resulting amount is a smaller taxable income, reducing the tax bill.
Tax credit works a little different. Every tax credit reduces dollar-for-dollar the amount you have to pay on your taxes. The majority of tax credits are not refundable, but some are, which means that if you owe the IRA $1000, but you also qualify for a tax credit of $2000, you will get a tax refund of $1000.
A tax credit can make a more significant difference in your taxes than a tax deduction. However, if you know how they work and plan, you can cut your total amount due and will not be surprised by an unexpected tax bill.
Here are some tips that can help you be ready for your income tax and save some money in taxes in the years 2019 and 2020.
Home office deduction
Sole proprietors and other self-employed professionals certainly use this. The IRS allows deducting the expenses related to the portion of your home, rent, utilities, real estate taxes, furniture, repairs, and other expenses – being used for business purposes.
Self-employment expenses deduction
Many more tax deductions here, mainly for sole proprietors, self-employed people, freelancers, and contractors. That’s why it is so important to keep track of all your business expenses during the year.
Earned Income Tax Credit
This credit depends on the number of kids in the household and also your marital status and yearly gross income. You can get between $529 and $6,557 in 2019 and between $538 to $6,660 in the year 2020.
Child tax credit
This is a tax credit for your child(s). It could help you save up to $2,000 per child and $500 for non-dependent children.
Charitable donations deduction
Get a deduction from the value of your gifts to charity or non-profit organizations— whether they are clothes, a car, cash, time, or property — from your taxable income.
IRA contributions deduction
You may be able to deduct contributions to a traditional IRA, though how much you can deduct depends on whether a retirement plan at work covers you or your spouse and how much you make.
401(k) contributions deduction
Get a deduction from the contributions to the IRS that are deducted directly from your paycheck into a 401(k). For 2019, you can funnel up to $19,000 per year into such an account. If you are 50 or older, you can contribute up to $25,000. In 2020, those limits are $19,500 and $26,000, respectively. These retirement accounts are usually sponsored by employers, although self-employed people can open their own 401(k)s.
Mortgage interest deduction
This is a big plus for homeowners and even for everybody else who is planning on buying a home. The mortgage interest tax deduction cuts the federal income tax that a qualifying homeowner has to pay by reducing the mortgage interest paid from the taxable income.
Medical expenses deduction
With the cost of health insurance sky-rocketing, this deduction helps reduce its financial burden by deducting all qualified, unreimbursed medical expenses that are more than 10% of your adjusted gross income for the tax year.