Tax Credits and Deductions Maximizing Opportunities for Savings
Tax credits differ from deductions because they reduce actual taxes owed dollar for dollar. These tax breaks are a great opportunity for small businesses and individuals to lower their income tax bills or increase their refunds.
Deductions are “above the line,” meaning they reduce your taxable income before your tax bill is calculated. However, tax credits are subtracted from your tax liability after the calculation.
1. Home Mortgage Interest Deduction
Home mortgage interest deduction reduces the amount of taxable income by deducting the homeowner’s interest payments from their federal tax bill. This benefit increases household wealth, and higher homeownership translates into greater consumer spending that boosts the economy.
But the mortgage interest deduction is largely used by higher-income households, and it encourages homeowners to take out larger loans and keep their home equity high. Larger mortgage balances and high home equity increases the risk that households could be stuck with mortgage debt they cannot pay if house prices decline.
Rather than scaling back or reforming the mortgage interest deduction, converting it to a credit would provide more help than today’s deduction for lower- and middle-income households while trimming subsidies for higher-income households. This approach would also reduce the deficit without jeopardizing economic growth or housing market recovery.
2. Child Tax Credit
Raising children is expensive, and even families with low incomes can have expenses like food, utility bills, clothing and education costs. Tax credits can help cover these expenses and encourage saving.
The Child Tax Credit, which is partially refundable, helps most families with children. Its benefits are correlated with health outcomes including lower food insecurity, reduced income volatility and better health.
Families can claim the CTC if their Modified Adjusted Gross Income (MAGI) is less than $200,000 for single filers and $400,000 for married filers. To qualify, children must meet age, relationship and support tests as well as citizenship and residency requirements. If you’re receiving the credit, consider stashing it in a no-fee savings account such as Marcus by Goldman Sachs High Yield Online Savings, Synchrony Bank High Yield Savings or Varo Savings.
3. Education Credits
For those who have a child in college, there are two tax credits that help offset tuition and fees. These are known as the American Opportunity Credit and the Lifetime Learning Credit.
The credit differs from deductions because it reduces taxes dollar-for-dollar, while deductions only reduce the amount of income that is subject to tax. The value of a tax credit can also increase or decrease with the taxpayer’s marginal tax rate, which rises as income increases.
The key to getting the maximum benefit from these credits is careful planning and record-keeping. A qualified tax professional can provide guidance on these and other credits. In addition, the accumulated earnings of a 529 plan may be tax-free when distributions are used to pay education expenses, boosting the benefits further.
4. Energy Credits
A tax credit reduces a filer’s tax liability dollar-for-dollar, while a deduction lowers taxable income by deducting an amount from the gross income. Tax credits are more valuable than deductions, particularly for low- and middle-income households, according to the Urban-Brookings Tax Policy Center.
For example, the bill extends and enhances the nonbusiness energy property credit for up to 30% of the cost to install efficient windows, doors, skylights, water heaters and furnaces in homes, as well as an electric vehicle charging station credit. It also adds battery storage as a new credit for renewable solar installations.
It also expands the renewable electricity production credit to pay 2.6 cents per kilowatt-hour for power generated by wind, solar, geothermal, small wind, biomass, microgrid controllers and combined heat and power properties.
5. Other Credits
There are several other tax deductions that can be useful, including contributions to traditional individual retirement accounts and above-the-line deductions like property taxes, says Josh. Eligible taxpayers can claim these deductions whether they itemize or take the standard deduction. The benefit of these above-the-line deductions is that they lower a filer’s adjusted gross income, which may help save money on Medicare Part B and Part D premiums, as well as other tax-deductible expenses.
In terms of saving money, a credit is more valuable than a deduction, according to financial experts. That’s because credits reduce a filer’s tax liability dollar for dollar, while deductions’ value depends on a person’s marginal tax rate, which rises as income increases. Keeping track of eligible expenses throughout the year and minimizing taxable income are key for maximizing tax benefits.