What is a tax deduction, credit and refund?

Jeramey By Jeramey, 28th Oct 2015 | Follow this author | RSS Feed | Short URL http://nut.bz/10er8gov/
Posted in Wikinut>Money>Tax

There is a big difference between a tax deduction and a tax credit, but which one gives you a refund?

What is a tax deduction?

Simply put, a tax deduction is a way of reducing the income you earned that is taxable.

This is commonly the result of expenses, whether business or personal.

The difference between deductions, exemptions and credit is that deductions and exemptions both reduce taxable income, while credits reduce tax.

As an example, if you made $50,000 and you paid 25% tax you would owe $12,500. If you qualified for and claimed a $2,000 tax deduction, you would have an adjusted income of $48,000 and thus would owe $12,000 in tax instead of $12,500.

If you made only $10,000 and made too little money to pay any tax (or any other reason to be effectively charged at a 0% rate), this same deduction would not give you a refund.

What is a tax credit (nonrefundable)?

As opposed to a deduction, which reduces your tax, there are two types of tax credits available for taxpayers: refundable and nonrefundable.

A nonrefundable credit means that, like a deduction, it can’t be used to increase your tax refund or to create a tax refund when you wouldn’t have already had one.

So if you made $50,000 and paid 25% tax you would owe $12,500. If you qualified for and claimed a $2,000 nonrefundable tax credit, you would owe $10,500.

If you made $20,000 and paid 25% tax you would owe $5,000. If you qualified for and claimed a $6,000 nonrefundable tax credit, you would not get $1,000 -- your tax would just be $0. You would not be able to collect the additional amount of the credit you claimed because it only reduces your tax owed.

What is a tax credit (refundable)?

Now for the good part... Tax credits that are called “refundable” are able to reduce your tax liability below zero and allow you to receive a tax refund. If you qualify for a refundable credit and the amount of the credit is larger than the tax you owe, you will receive a refund for the difference.

Unlike the previous examples, with refundable credits you can still use the credit even if you have no tax liability.

So if you made $50,000 and paid 25% tax you would owe $12,500. If you qualified for and claimed a $2,000 refundable tax credit, you would owe $10,500.

If you made $20,000 and paid 25% tax you would owe $5,000. If you qualified for and claimed a $6,000 refundable tax credit, you would receive a refund of $1,000.

Tags

Tax Credits, Tax Deductions, Tax Planning, Tax Refunds, Tax Saving Strategies, Tax Strategies, Taxes

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author avatar Jeramey
Multi-discipline autodidact. Interested in everything from history, economy, language, progressive politics, and film.

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Comments

author avatar Nancy Czerwinski
29th Oct 2015 (#)

Thanks for sharing your article. I found it interesting.

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author avatar Jeramey
29th Oct 2015 (#)

Thanks, Nancy! You're welcome.

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author avatar Fern Mc Costigan
29th Oct 2015 (#)

Interesting post!

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author avatar Jeramey
29th Oct 2015 (#)

Thanks, Fern! Glad you enjoyed it.

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