Tax Credits Are Often More Valuable Than Deductions
What you'll learn: The difference between tax credits and tax deductions
EXPECTED READ TIME:4 MINUTES
February 12, 2021
If you’re confused about the difference between a tax deduction and a tax credit, you’re not alone. Here’s a quick breakdown to help you understand these terms and how they might impact you.
A deduction is subtracted from your income, lowering your taxable income and your income tax — think of it as reducing how much of your income is subject to taxes. But a tax credit kicks in after you’ve computed your income tax, reducing the amount of taxes you owe, dollar-for-dollar.
When filing your taxes, you must choose between taking a standard deduction or itemizing your deductions. Since the standard deduction is now $12,400 per taxpayer, and even more for seniors over 65, itemizing won’t benefit most people unless they have a hefty home mortgage or huge medical expenses.
But even if you take the standard deduction, there still are a few deductions you can claim and many credits for which you might qualify. Here are some of the more popular ones.
- Student Loan Interest Deduction: You may be able to deduct up to $2,500 of student loan interest if your income is less than $85,000 on a single return (double that if filing jointly).
- Educator Expenses Deduction: School teachers can deduct up to $250 for classroom supply expenses.
- HSA Contributions Deduction: If you had high-deductible health coverage in 2020, you could contribute up to $3,550 to a Health Savings Account to pay for medical expenses ($7,100 for family coverage).
- Retirement Plan Contributions: You may have a traditional 401(k) or other retirement accounts available to you at work. Contributions to plans such as a 401(k), 403(b), and profit-share plans are tax-deductible up to $19,500 ($26,000 if you are 50 or older). Contributions to traditional IRAs or other individual retirement accounts may also be deductible. You might also qualify for a Saver’s Credit of up to 50% of your first $2,000 in retirement plan contributions if your income is under $32,000.
- Education Tax Credits: If you’re paying for college for yourself or your kids, the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC) may help. The AOTC credit covers 100% of the first $2,000 you spend on education and 25% of the next $2,000. The LLC lets you claim 20% of the first $10,000 you paid toward tuition and fees. The income limit for claiming the AOTC is $90,000, and the limit for claiming the LLC is $69,000.
- Child Credits: You can get a Child Tax Credit of $2,000 per child ($500 for non-child dependents) if your income is under $200,000 ($400,000 on a joint return.) Also, you can get a credit of 20-35% of the first $3,000 for child and dependent care costs, or double that if there are two or more dependents. If you adopt a child, you can claim credit for up to $14,300 of adoption costs per child if your income is under $254,520. And if your income is under $57,000, you may also qualify for an Earned Income Tax Credit of up to $6,660, depending on your marital status and how many kids you have.
- Residential Energy Credit: If you installed solar equipment in 2020, you may qualify for a tax credit of 26% of the cost. The credit reduces to 22% throughout 2021.
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The information in this article is for general educational purposes only and not intended to provide specific advice or recommendations. Please discuss your particular circumstances with an appropriate professional before taking action.