February 28

What are tax credits and tax deductions?

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Tax Credits

A tax credit is an amount of money that a taxpayer can subtract directly from the tax liability you owe the government. Because a tax credit reduces the amount of taxes you owe, in most cases it is preferable to have a tax credit rather than a tax deduction.

Tax credits come in two different forms:

  • a refundable tax credit and
  • a non-refundable tax credit.

Most tax credits are non-refundable.

That means the credit can reduce your tax liability to zero and not below. A refundable tax credit can reduce your tax liability below zero creating a tax refund. Notable exceptions include the Earned Income Tax Credit (EIC), Child Tax Credit (CTC), for health insurance the Premium Tax Credit (PTC) and tax credits for higher education such as the American Opportunity Tax Credit. Some of the refundable tax credits may have some limitations on how much is refundable. Generally, in order to take advantage of tax credits, there may be some income limitations in order to qualify for use of the credit.

Sometimes the filing status on your tax return can disqualify you from using a tax credit. If you are married and your filing status is married filing separate, use of some tax credits may be eliminated. If you are divorced, sometimes it may be possible to negotiate the use of tax credits with your ex-spouse when it comes to tax benefits relating to your children.

Tax Reductions

A tax deduction is a reduction to the amount of taxable income your tax liability is calculated on. Before the “Tax Cuts and Jobs Act” (TCJA) enacted in 2017, most tax deductions were listed on IRS form Schedule A “Itemized Deductions”. Many of the deduction on Schedule A were taken advantage of by taxpayers every year. Generally, the deductions were for:

  • medical expenses,
  • state and local taxes (SALT),
  • both income tax and property taxes,
  • mortgage interest,
  • charitable deductions
  • and some miscellaneous expenses such as office in home, investment management fees, tax preparation fees casualty losses and several other types of deductions.

Standard Deductions

The tax code sets a floor or minimum for the standard deduction taxpayers were able to take. The TCJA increased the floor or minimum deduction you could use and limited the deduction for state and local taxes. For example, in 2017 the standard deduction was $12,700 for a married couple filing a joint return. TCJA increased the floor to $24,400 for a married couple filing a joint return. Because of the limitations placed on the SALT deduction and the increase of the standard deduction for most taxpayers there is no advantage to using the schedule A form because their deductions did not exceed the floor of $24,400.

Schedule 1 Deductions

There are some deductions that appear on the personal income tax form (1040) that may be of value to you. At present the items appear on Schedule 1 for your tax return. These deductions relate to:

  • personal expenses paid by an educator,
  • Health Savings Accounts,
  • Penalty on early withdrawal of savings,
  • contributions to retirement accounts
  • and the interest expense you paid on a student loan.

Self employed or Divorced?

For self-employed taxpayers there is a deduction for your health insurance premium and ½ of your Social Security tax. If you are divorced and paying or receiving alimony payments, adjustments for payments are made on Schedule 1 for divorce decrees completed before 2019. If your divorce decree is finalized after 2018 you are no longer able to deduct alimony payments you make and you do not claim as income alimony payments you receive.

The TCJA complicated the completion of a personal return. Are you aware of and taking advantage of the deductions and tax credits you are entitled to?

Brent Hamilton, CFP & EA
Brent Hamilton, CFP and Enrolled Agent.

We can help.

I’m Brent Hamilton, Enrolled Agent (in other words if I do your taxes I can represent you just like a lawyer before the IRS)

Schedule a meeting today at 503 699-9200

About the author 

Brent Hamilton

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What are tax credits and tax deductions?

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