Tax credit and tax deduction are two common tax terms that often create confusion among people. Here's the difference between them.
A tax deduction is a reduction in the taxable income of a person or a company. It reduces the overall amount of income that is subject to taxation. The deduction is allowed based on certain expenses, such as state and local taxes, charitable contributions, and mortgage interest.
For example, if a person's salary is $50,000 and they have $10,000 in allowable tax deductions, their taxable income is reduced to $40,000. They will only pay taxes on $40,000.
On the other hand, a tax credit is a dollar-for-dollar reduction in the actual amount of tax owed. It is a direct reduction in the tax bill, rather than a reduction in taxable income.
For example, if a person owes $5,000 in taxes and qualifies for a $2,000 tax credit, their tax bill is reduced to $3,000.
The major difference between tax credits and tax deductions is that tax credits directly reduce the amount of tax owed, whereas tax deductions reduce the amount of taxable income on which the tax is calculated.
It's also important to note that not all taxpayers are eligible for all tax credits or tax deductions. Eligibility for tax credits or deductions often depends on factors such as income, filing status, and expenses incurred during the year.
In conclusion, taxpayers should be aware of the difference between tax credits and tax deductions when filing their tax returns. Taxpayers should take advantage of all eligible credits and deductions to minimize their tax liability, but they should also be cautious not to attempt to claim credits or deductions that are not legally allowable. It's recommended to seek guidance from certified tax professionals if there's any confusion or uncertainty regarding tax laws and regulations.
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