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If paying taxes makes you cringe, tax credits and deductions should make you smile. They can help to reduce your tax burden.
In brief
- The IRS has a long list of tax credits and tax deductions. Do you know the difference and which ones may be applicable to your situation?
- A tax credit is applied against your tax liability.
- A tax deduction is applied against your taxable income.
- Need assistance? EY TaxChat™ is here to help.
You often hear the terms tax credit and tax deduction but understanding the difference between the two — and the impact they have on your federal and state filings — is critical.
A tax credit is a dollar-for-dollar reduction of your tax liability, or the amount of tax you owe. For example, if your tax liability is $1,500, a $500 credit brings it down to $1,000.
- Some tax credits are non-refundable. If the credit amount is more than your tax bill, the excess credit won’t result in a refund check, but could reduce your tax bill to zero.
- Some tax credits are refundable, such as the Earned Income Tax Credit or the Child Tax Credit. A refundable credit is just how it sounds, if you qualify for a larger credit than your actual tax bill, you will be allowed the full credit and should expect to see a refund.
A tax deduction is a dollar-for dollar reduction of the amount of income that’s subject to taxation. So, if your income is $50,000, a $1,000 deduction reduces your taxable income to $49,000. And you could pay less tax as a result. (Other circumstances may apply.)
Standard deduction vs. itemized deduction
Standard deduction is a fixed rate deduction based upon your filing status. For tax year 2022, the standard deduction allowed is anywhere from $12,950 (single filers) to $25,900 (married filing joint filers).
Itemized deduction is an alternative to the standard deduction. If you have allowable deductions, such as mortgage interest, charitable donations, state income taxes, real estate taxes, etc., and the total of these deductions is above the standard deduction amount, you will benefit from taking the higher itemized deduction. In the end, this will reduce your taxable income more than the standard deduction, thus ultimately reducing your overall tax bill.
About EY TaxChat™
EY TaxChat is an on-demand mobile service that connects you with a licensed tax professional who will prepare your taxes and file them for you. Click here to learn more and register for EY TaxChat at any time, from anywhere, or by downloading the app from the Apple App Store or GooglePlay Store.
This information is provided solely for educational purposes; it does not take into account any specific individual or entity’s facts and circumstances. It is not intended, and should not be relied upon, as tax, accounting or legal advice. Ernst & Young LLP expressly disclaims any liability in connection with the use of this presentation or its contents by any third party. Neither EY nor any member firm thereof shall bear any responsibility whatsoever for the content, accuracy or security of any third-party websites referenced.
Summary
Tax credits and tax deductions do impact your filings differently but are an equally welcomed benefit to most taxpayers. Some may have qualifying requirements and/or income limitations. As a result, you may notice that you could qualify for only a partial credit or deduction, and in some cases the amount could be completely phased out to zero. Need help sifting through the various credit and deduction benefits? Please see your EY TaxChat professional for further guidance.
