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Tax Deduction vs. Tax Credit
The first thing to understand about tax benefits for individuals is that they fall into two main categories:
- Tax deductions – Deductions reduce your income upfront.
- Tax credits – Credits reduce your tax bill at the end.
Your tax deduction reduces your taxable income. There are tax deductions that you get for certain expenses, like moving and student loan interest, without the need to take special action. Additional deductions, like those you take for business expenses or that you itemize instead of claiming a standard deduction, require extra paperwork.
Because tax deductions reduce your income, the amount of tax you pay is lower because your taxable income is lower.
Credits, on the other hand, act similarly to gift cards. You apply a tax credit to the actual tax you owe at the end of the process. Some credits will only go so far as to take your tax bill to $0, while other credits are refundable, meaning they result in getting money back from the government.
Tax Deductions for Individuals
When preparing your taxes, the first step is to figure out how much of your income is taxable. Your deductions help with that. Here are some of the deductions you can expect:
The standard deduction is used for every tax filer. It’s based entirely on your filing status. For tax year 2019, the standard deduction is:
- Single: $12,200
- Head of household: $18,350
- Married filing jointly: $24,400
For tax year 2020, the standard deduction is:
- Single: $12,400
- Head of household: $18,650
- Married filing jointly: $24,800
In general, it doesn’t make sense to itemize your deductions if the total is less than you’d see with a standard deduction. For example, if you’re married filing jointly and you add up all your itemized deductions and they amount to less than $24,400 for 2019, it makes more sense to just take the standard deduction to reduce your income by a larger amount.
Itemized tax deductions
You can choose to take the standard deduction, but in some cases, it makes more sense to itemize. If all of your itemized deductions add up to more than the standard deduction, you’ll reduce your income more effectively. Here are some of the tax benefits for individuals that you can itemize:
- Charitable contributions
- Certain state and local taxes
- Home mortgage interest
- Certain expenses required by your employer
- Medical expenses that reach a certain level
- Some gambling losses
Carefully consider your itemized deductions before moving forward. In most cases, you need some type of receipt to prove that you can take the deduction. Additionally, realize that you might be subject to a floor or a limit on some of these itemized deductions. For example, for 2019, you can only deduct the medical expenses that exceed 7.5% of your income. For tax year 2020, you can deduct medical expenses that exceed 10% of your income.
Business-related tax deductions
If you own a business, there are a number of tax deductions you can claim as an individual to help you reduce the amount of income that the government taxes:
- Business expenses – including the purchase of office supplies and equipment, travel, and the use of your home office
- Standard mileage rates – for when you drive for your business, as well as business use of your car
- Bad debt
- Business entertainment expenses
Depending on your tax election with the IRS, you might put this information on your Schedule C, or it might be part of other business forms. Make sure you understand the situation, and where to report business deductions.
Education-related tax deductions
If you’re going back to school, or if you have a dependent that you’re paying for, here are some tax deductions available to you:
- Teacher educational expenses
- Student loan interest
- Tuition and fees
- Work-related education expenses for improving your performance
Healthcare tax deductions
While you can itemize certain medical and dental expenses, it’s also worth noting that you can also claim a tax deduction for your contributions to a Health Savings Account (HSA). If you qualify for an HSA, this can be a great tool because the money gets you a tax deduction, but it also grows tax-free as long as you use it for qualified healthcare expenses.
Investment-related tax deductions
If you’ve experienced losses in your investment portfolio, you can use those to offset some of your gains or even to reduce a portion of your income. It’s also possible to claim tax deductions for contributions to a traditional 401(k) or IRA.
Tax Credits for Individuals
Now that you’ve reduced your taxable income with the help of tax benefits for individuals, it’s time to consider the tax credits that directly reduce your tax bill.
Family and dependent tax credits
There are credits available for the costs you pay related to expanding or taking care of your family, including:
- Earned Income Tax Credit
- Child and Dependent Care Credit
- Adoption Credit
- Child Tax Credit
- Credit for the Elderly or Disabled
Income and savings tax credits
There are several different tax credits you can claim based on your income, where you earn your money, and whether you’re saving some of your income. Here are some of the credits available to you based on your cash flow situation:
- Earned Income Tax Credit
- Foreign Tax Credit
- Credit for Tax on Undistributed Capital Gain
- Credit to Holders of Tax Credit Bonds
- Saver’s Credit
- Nonrefundable Credit for Prior Year Minimum Tax
- Excess Social Security and RRTA Tax Withheld
Education tax credits
If you’re taking advantage of a higher education, you might qualify for either the Lifetime Learning Credit or the American Opportunity Tax Credit. Either of these can help you offset the cost of attending college by reducing the amount of tax that you owe. Realize, though, that there are some limitations so check those before you move forward.
Healthcare tax credits
There are also tax credits available for those who qualify as a result of the Affordable Care Act. With the Premium Tax Credit and the Health Coverage Tax Credit, you can reduce some of the overall cost of paying for healthcare coverage.
Do You Qualify for Tax Benefits for Individuals?
While there are a lot of tax benefits for individuals available, it’s important to understand that you might not qualify for all of them.
Many tax deductions and credits come with income restrictions and some phase out when you reach a certain income level. For example, you can’t claim a Premium Tax Credit if you make more than 400% of the federal poverty level for your household size. Additionally, some deductions, like the student loan interest deduction, phase out and disappear as your income rises.
Additionally, you might have to choose between taking a tax deduction or a credit. In those cases, run the numbers to see what makes the most sense for you. If the deduction is big enough to help you lower your income so it’s in a different bracket, and the credit in question is nonrefundable, it might be worth it to take the deduction.
However, most of the time, if you qualify for a refundable tax credit, it’s almost always worth it to take it if there’s an opposing deduction.
Get help with your taxes
Because there’s so much going on with tax law all the time, it’s important to understand what you qualify for so that you aren’t over-paying. You can get help with your taxes to make sure you don’t pay more than you owe.
Software programs like TurboTax and TaxAct ask you questions about your situation and can help you figure out which tax deductions and credits you qualify for. If you’re not comfortable using tax software, you can use tax preparation services like H&R Block and Liberty Tax. Finally, for those who have more complicated and specialized tax returns, a CPA can help you make sense of your tax return.
No matter your situation, it’s possible to find out what tax benefits for individuals are available for you, and then use them to keep more of your money.