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February 04, 2010
Tax Deductions and Credits
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With tax season around the corner, now is a good time to think about tax deductions or credits you might take. If you’re unfamiliar with deductions and credits, here are some simple explanations.
Tax Deductions
Tax deductions reduce your gross income. By doing this, deductions can decrease how much you owe in taxes.
For example: If your income was $50,000 and you deducted $2,500 for student loan interest you paid, your taxable income would be $47,500. This deduction ends up decreasing how much you owe overall, because the income you pay tax on is now a smaller number.
Keep in mind that deducted money doesn’t get applied directly to your return. The $2,500 you subtracted reduces how much income you report, so the amount you owe in taxes will most likely be reduced by less than the $2,500 deduction.
Standard and Itemized Tax Deductions
Most taxpayers claim the standard deduction—a fixed amount that reduces the income on which they are taxed. However, instead of claiming the standard deduction, you can choose to itemize tax deductions.
Itemized deductions might include money you spend on health care, state and local taxes, mortgage interest, charitable donations, and tax preparation fees. If your total itemized tax deductions are more than the standard deduction, it's usually a good idea to itemize. For example, purchasing a home usually makes it worthwhile to itemize deductions, because you can deduct interest, real estate tax, and—for loans taken out after 2006—certain mortgage insurance premiums.
Tax Credits
Unlike tax deductions, tax credits are subtracted from the final amount of tax you owe.
For example: If you owed $2,000 but qualified for a full Lifetime Learning Credit of $2,000, you would no longer owe any money.
Also, if you are eligible for a tax credit that exceeds the amount you owe, you may qualify for a refund.
Education Tax Deductions and Credits
There are a number of tax credits and deductions available if you are in school or repaying student loans. Learn more about all of the the tax incentives for students.
This document was prepared for informational purposes only and cannot be considered tax advice or otherwise. Please see your tax professional for additional guidance.
