Tax Credit Versus Tax Deduction
October 4th, 2009
Question: Difference between tax credits and tax deductions for single tax payers in the 25% tax bracket?
Demonstrate the differences resulting from a $1,000 tax credit versus a $1,000 tax deduction for a single tax payer in the 25% bracket with $40,000 of pretax income.
Answer: A deduction is simply a reduction in the amount of taxable income. Therefore, if you claim a $1000 deduction, you will reduce your taxable income by the same amount. If you are in a 25 percent tax bracket then your total tax savings from this $1000 reduction in taxable income would be $250 (25% of $1000). On the other hand a tax credit is a dollar for dollar reduction in your tax liability. Therefore if you were able to take a $1000 tax credit, you would reduce your tax liability by the full amount of the credit, or $1000…a much better deal.
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When Bill Thomas was chairman of the tax-writing House Ways and Means Committee, he thought too much emphasis was being placed on home ownership. “If you can afford to buy a house, you are rewarded handsomely in a number of financial ways. If you can’t, you are punished because you pay rent. You can’t even subtract rent from your income tax,” said Thomas, who retired in 2006 after representing …
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