Tax deductions and tax credits are usually referred to as the same by most people. They can definitely make a big impact and cut down your tax bill significantly, but in different ways. Read below to learn what are the differences— along with some of my favorite tips for saving money this tax season.
What’s the difference between a tax credit and a tax deduction?
A tax deduction helps to lower your 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. When you have the total income, you start subtracting each one of the deductions from the total, making your taxable income smaller and the tax bill as well.
A tax credit works a little different. Every tax credit actually reduces dollar-for-dollar the amount you have to pay on your taxes. The majority of tax credits aren’t 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 bigger difference in your taxes than a tax deduction. But if you know how they work and plan ahead, you can cut your total amount due and won’t 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 years 2019 and 2020.
- Home office deduction
This is very used by sole proprietors and other self-employed professionals. The IRS allows you to deduct the expenses related to the portion of your home, rent, utilities, real estate taxes, furniture, repairs and other expenses – when you use it 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’s so important to keep track of all your business expenses during the course of the year.
- Earned Income Tax Credit
This credit depends on how many kids you have 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 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 a non-dependent children.
- Charitable donations deduction
You can get a deduction from the value of your gifts to charity or non a non-profit organization— whether they’re clothes, a car, cash, time or property — from your taxable income. Read more on attorney Peter E. Alizio‘s Tax Blog
- IRA contributions deduction
You may be able to deduct contributions to a traditional IRA, though how much you can deduct depends on whether you or your spouse is covered by a retirement plan at work 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’re 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 home owner 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 it’s financial burden by deducting all qualified, unreimbursed medical expenses that are more than 10% of your adjusted gross income for the tax year.