Tax credits and deductions both reduce tax liability, but in different ways. Tax deductions are qualifying expenditures that reduce taxable income. Tax credits, on the other hand, directly reduce the total tax liability, not taxable income.
Tax deductions are expenditures on which no taxes are charged. When filing your tax return, you deduct the amount of taxes you do not need to pay on certain qualifying expenditures. These deductions bring down your tax liability. For example, teachers can use the tax deduction for classroom supplies and other school materials that they purchased out of their own pocket in 2013. The deduction expired in 2013 and, therefore, can be claimed on this year’s filing, but not in future tax years (unless Congress renews the deduction). The deduction limit is $250 per teacher.
Along with tax deductions, you can also claim tax credits. Each tax credit has certain qualifying factors. For example, the child tax credit has various eligibility factors, including the age, relationship, and employment status of the child. Child tax credit allows taxpayers to reduce $1,000 per qualifying child from their tax liability (not taxable income). Earned Income Tax Credit (EITC) is another popular tax credit available to low and middle-income groups.
Standard Deduction or Itemized Deduction
When preparing returns, the taxpayer must choose whether to use itemized deductions or the standard deduction. It is generally recommended that taxpayers itemize their deductions if the total savings are greater than the standardized deduction. The old and the physically challenged receive higher standard deduction. For other taxpayers, the standard deduction for 2013 for single taxpayers is $6,100. The standard deduction for married filing jointly is $12,200.
Itemized deductions, if higher than the standard deduction, help taxpayers save more taxes. Some of the itemized deductions include charitable contributions, home equity loans, state and local taxes, and certain medical expenses.
When preparing tax returns, it is important to be aware of all the credits and deductions you can qualify for. Each credit or deduction helps you to keep more of your income. Many taxpayers hire professional help for return preparation to accurately file taxes and gain all benefits allowed to them by the government through credits and deductions. Correct filing of taxes is important to avoid understatement of taxes, which is a popular reason for tax debt.