How to Calculate Tax Credits

How to calculate tax credits vs. deductions
How to calculate tax credits vs. deductions

Taxpayers often use the terms "deduction" and "credit" as though they're the same thing. They are not. They're actually very different terms, and being aware of the distinctions between the two can help you make good choices at tax time -- and maybe put some extra money back in your pocket.

A deduction is a reduction in your taxable income, while a credit is a reduction in your taxes due.

Deductions are calculated as part of your taxable income (you'll find taxable income on line 43 on your form 1040). They are subtracted from gross income, including wages, interest and dividends, and may even be listed on a separate form, such as a Schedule A. Maximizing those deductions allows you to reduce your overall taxable income. Your tentative tax due is calculated from your taxable income.

Credits are applied to your tentative tax and reduce the overall tax due on a dollar for dollar basis. Popular credits for 2010 include the Making Work Pay Credit, the American Opportunity Credit and the Earned Income Tax Credit.

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