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Is It Better to Have a Tax Credit or a Deduction?

These tax benefits are generally assumed to be quite similar when they are really quite different.  The benefits of each category may surprise you.  


People often say that an expense is “a tax write-off”; most everyone interprets this to mean that the expense will have a tax benefit. Generally, such a benefit takes the form of either a deduction or a credit; the effects of these benefits are quite different, however, and each type has various categories. As a result, the tax implications may not be as expected. This is especially true when the write-off claim comes from a salesperson who is touting the tax benefits of a product or service, as such individuals often leave out key details. In general, a deduction reduces taxable income, whereas a credit reduces the tax itself. Hippo Tax Services can help you decipher whether you are looking at a tax credit or a tax deduction and how they will ultimately change your tax liability. 

Tax Deductions – In one way or another, tax deductions reduce the taxable portion of an individual’s income, which thus reduces the tax on that income. A good way to think of this is that it is not a dollar for dollar decrease in your tax liability. For every dollar you have in a deduction you will get some percentage off of your overall tax based on your tax bracket.

Itemized Deductions – When taxpayers think of deductions, they typically think of the itemized deductions that are claimed on Schedule A. This is the only way to deduct personal expenses such as medical costs, state and local tax payments, investment and home mortgage interest, charitable contributions, disaster-casualty losses and various rarely encountered expenses. In some cases, itemized deductions are limited. For instance, medical expenses are only deductible to the extent they exceed 10% of the taxpayer’s adjusted gross income (AGI). Similarly, state and local tax payments (including those for income, sales, and property taxes) are capped at $10,000. On top of that, itemization only reduces taxable income to the extent that the total of the itemized deductions exceeds the standard deduction. When the sum does not exceed the standard deduction, the itemized deductible expenses provide no tax benefits at all. 

Above-the-Line Deductions – Certain deductions actually reduce income. These are commonly called "above-the-line deductions" because, when applied, they reduce the income figure that is used to calculate AGI. Thus, their benefits apply regardless of whether the taxpayer uses itemized deductions. Above-the-line deductions include educators’ expenses; contributions to health savings accounts, traditional IRAs, and certain qualified retirement plans; qualified deductible alimony payments; and student-loan interest. Most of these deductions have annual maximums and some have income restrictions.

Business Deductions – Taxpayers who operate non corporate businesses can deduct from their business income any expenses that they incur when operating their businesses. These deductions (which cover advertising fees, employee wages, office-supply costs, etc.) are used to reduce profits, which in turn reduce taxable income and therefore income tax. In addition, most self-employed taxpayers pay Social Security and Medicare taxes on their net business income, so any reduction in their business profits also reduces their Medicare taxes and possibly their Social Security taxes. 

Asset-Sale Deductions – An individual who sells an asset is allowed to deduct that asset’s cost from the sale price to determine the taxable profit. Good record keeping is helpful here because the original expense may have been incurred in years prior, even though it is only deductible when the asset is sold. For example, any improvements that an individual makes to a home over years of ownership are not deductible until the home is sold. At that point, the individual can reduce the taxable gain from the sale by counting the improvements as part of the home’s cost. 

Tax Credits – Tax credits come in several varieties, and the amount of the benefit can vary: 

Refundable Credits – A refundable credit offsets current tax liability; it is so called because any amount of unused credit is refunded to the taxpayer. Refundable credits include the Earned Income Tax Credit, the Additional Child Tax Credit, and the Premium Tax Credit (net of any advances received), as well as the American Opportunity Tax Credit (an education credit that is 40% refundable). As a matter of general interest, these credits are subject to significant filing fraud because of their refundability. 

Nonrefundable Credits – A nonrefundable credit only offsets tax liability; any unused amount is lost unless it can be carried over to another year. Over time, Congress has become more generous with credits; most credits that are not refundable now carry over for a given period. Nonrefundable credits include the Saver’s Credit, the Lifetime Learning Credit, and the personal portion of the Electric Vehicle Credit. 

Carryover Credits – For some nonrefundable credits, any unused current-year credit can be carried over to the next tax year (or for a longer period) until the carryover amount is used up. These credits include the Adoption Credit (which can carry over for up to five years) and the Home-Solar Credit (which carries over through at least 2021; tax law is unclear on whether it will expire then). 

Business-Tax Credits – Numerous business-tax credits are available; however, they are grouped into the General Business-Tax Credit, which is nonrefundable but which carries forward for twenty years and back for one year. This allows a business owner to amend the prior year’s return so as to claim the credit. This category includes the business portion of the Electric Vehicle Credit.  

If you have questions related to how you might benefit from tax credits or deductions, please call Hippo Tax Services so we can walk you through the various items and their corresponding tax effect.

Please check with your Curran Wealth relationship manager,
or contact Curran Wealth Management if you have any questions.
 518.391.4200 •
info@curranllc.com

The material contained in this article is for educational and informational purposes only.  The information herein is considered to be obtained from reference sources deemed reliable, but no representation or warranty is made as to its accuracy or completeness.  This article is not, and should not be regarded as “investment advice” or construed as a “recommendation” or an offer to buy or sell a security.  The information contained in this article may not apply to your personal circumstances.  Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation.  Information on taxes is based on the tax laws existing at the time of publication.  Tax laws are subject to continual change.  In addition, tax laws vary by state.  This article is not, and should not be regarded as tax or legal advice.  We cannot ensure tax consequences of any transaction.  If you would like a detailed analysis of your tax situation, with specific tax recommendations, you can discuss the possibility of pursuing a formal relationship with Hippo Tax Services, LLC.