D3sign | Moment | Getty Images
It’s tax season, and households are confronted by a lot of tax jargon when preparing their returns.
Two types of tax breaks stand out among all the lingo: credits and deductions.
Each lowers your tax liability, which is the total annual tax owed on your income. (That figure can be found on line 24 of Form 1040, the IRS form for individual income tax returns.)
However, credits and deductions reduce tax liability in different ways. Here’s how.
Tax credits offer a dollar-for-dollar reduction in liability
A tax credit offers a dollar-for-dollar reduction of your taxes. It has the same dollar value for any taxpayer who can claim it.
For example, let’s say you get a $1,000 tax credit and have a $5,000 tax liability. That credit would cut your liability to $4,000.
Tax credits are generally more valuable to taxpayers than deductions (more on that below), and tend to be more targeted to low- and middle-income households, said Ted Jenkin, a certified financial planner and co-founder of oXYGen Financial, based in Atlanta.
Low-income filers may not get a credit’s ‘full benefit’
Not all credits are created equal. So-called nonrefundable credits — like the child and dependent care credit — can’t reduce a filer’s tax liability below zero. That means an individual wouldn’t get any excess value back as a cash refund; the leftover portion is forfeit.
Most credits are nonrefundable, according to the Urban-Brookings Tax Policy Center. Others are partially or fully refundable, meaning that some or all of the credit can be applied as a tax refund.
Low-income filers “often cannot receive the full benefit of the [nonrefundable] credits for which they qualify,” the Tax Policy Center said. That’s due to the progressive nature of the U.S. federal tax system, whereby lower earners generally have a lesser tax liability than higher earners.
By comparison, the child tax credit is an example of a partially refundable credit. The credit is worth up to $2,000 per child…
Read the full article here
