Credits and Deductions

Understanding the Difference


Added 8/25/05

 It seems that the average taxpayer does not understand the difference between a credit and a deduction.

 A credit is deducted from the tax owed, while a deduction is deducted from income before the tax is calculated. Most deductions are “itemized”, while a few are “above the line”.  For now, just be aware that “above the line deductions” are more favorable than “itemized” deductions. 

Credits are further split into:  Refundable and non-refundable.  A refundable credit will be paid to you in cash.  This is over and above the amount of any regular refund generated by too much withholding.  A non-refundable credit can only reduce your tax to zero.

 Some of the more obvious deductions are:

A not so obvious “above the line” deduction is $2,000 for the purchase of an approved hybrid car (gas & electric engine automobile).  The latest approved model is the 2006 Toyota Highlander.  Some other qualifying cars are the Prius and some Ford models.  A new hybrid car purchased in 2006 will only get you a $500 deduction.

 Some of the more obvious non-refundable credits are:

 Some of the less obvious non-refundable credits are:

Some of the more obvious refundable credits are:

 

There are two not so obvious refundable credits:

 

As a general rule, credits are of more value than deductions, especially if you are in the 15% tax bracket.  In some cases, the higher education “above the line” expense of $4,000 results in less tax than the Hope or Learning Tax Credits – especially for joint taxpayers with incomes over $100,000.

 

In any event, be sure to remember that there is a world of difference between a tax deduction and a tax credit and that an “above the line” deduction is much more favorable than an “itemized” deduction.