A tax deduction cuts the amount of income you are taxed on, which can mean a lower bill. However, a tax credit cuts your tax bill directly. Tax deductions and tax credits can be huge money-savers — if you know what they are, how they work and how to pursue them.
What is a tax deduction?
A tax deduction is a dollar amount that the IRS allows you to subtract from your adjusted gross income, or AGI, making your taxable income lower. The lower your taxable income, the lower your tax bill.
What is a tax credit, then?
A tax credit is a dollar-for-dollar reduction in your actual tax bill. A few credits are refundable, which means if you owe $250 in taxes but qualify for a $1,000 credit, you will get a check for the difference of $750. (Most tax credits, however, are not refundable)
How to claim tax deductions
Generally, there are two ways to claim tax deductions: Take the standard deduction or itemize deductions. You cannot do both.
The standard deduction
The standard deduction is basically a flat-dollar, no-questions-asked reduction in your AGI. The amount you qualify for depends on your filing status.
Itemizing allows you to cut your taxable income by taking any of the hundreds of available tax deductions you qualify. The more you can deduct, the less you will pay in taxes.
Should you itemize or take the standard deduction?
Here is what the choice boils down to:
· If your standard deduction is less than the sum of your itemized deductions, you probably should itemize and save money. Beware, however, that itemizing usually takes more time, requires more forms, and you will need to have proof that you are entitled to the deductions.
· If your standard deduction is more than the sum of your itemized deductions, it might be worth it to take the standard deduction (the process is faster).
Note: The standard deduction went up significantly in 2018, so you might find that it is the better option for you now even if you have itemized in the past.
Your CPA/Tax Advisor can run your return both ways to see which method produces a ways to lower tax bill.
20 popular tax deductions and tax credits for individuals
There are hundreds of deductions and credits out there. Here is a list of some common breaks for 2019-2020
Student loan interest deduction
American Opportunity Tax Credit
Lifetime Learning Credit
Child and dependent care tax credit
Child tax credit
Earned Income Tax Credit
Charitable donations deduction
Medical expenses deduction
Deduction for state and local taxes
Mortgage interest deduction
Gambling loss deduction
IRA contributions deduction
401(k) contributions deduction
Health Savings Account contributions deduction
Self-employment expenses deduction
Home office deduction
Educator expenses deduction
Residential energy credit