How to Calculate Tax Credits

How to calculate tax credits vs. deductionsTaxpayers 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.It's best explained with an example. Let's say you're a single taxpayer with adjusted gross income of $20,000 after your standard deduction. The tax on $20,000 is $2,582.50 (using the tax brackets, that's $835 plus 15% of the amount over $8,350). An additional $500 in deductions would result in tax due of $2,507.50.

But what if, instead of deductions, you had additional credits of $500? The $500 credit would reduce that initial tax, dollar for dollar, from $2,582.50 to $2,082.50.

In this example, opting for the credit over the deduction resulted in a tax savings of $425. So when all else is equal, it's generally more favorable to take advantage of a credit than a deduction. This is good to know when faced with the option of claiming a deduction or a credit when both may not be allowed -- educational expenses are a good example.

Credits may also be refundable, which means that to the extent you have more credits available than tax owed, you are eligible for a refund. Deductions are never refundable since they are a reduction in your taxable income: reducing your taxable income below zero does not result in an additional refund.

Remember: A credit is a dollar for dollar reduction in your tax due. To the extent you can maximize those credits, your overall tax burden will be reduced -- and you might even be getting some money back.

Tax Tips for Real Estate Agents and Brokers

Most real estate agents and brokers receive income in the form of commissions from sales transactions. You're generally not considered an employee under federal tax guidelines, but rather a self-employed sole proprietor, even if you're an agent or broker working for a real estate brokerage firm. This self-employed status allows you to deduct many of the expenses you incur in your real estate sales or property management activities. Careful record keeping and knowing your eligible write-offs are key to getting all of the tax deductions you're entitled to.

Read More

Brought to you by TurboTax.com

What is the Educator Expense Tax Deduction?

The Educator Expense Tax Deduction allows teachers and certain academic administrators to deduct a portion of the costs of technology, supplies, and certain training. Here’s what teachers need to know about taking the Educator Expense Deduction on their tax returns.

Read More

Brought to you by TurboTax.com

Self-Employed Less Than a Year? How to Do Your Taxes

Have you been self-employed less than a year? If you’re just starting out, it’s possible you worked at a job earlier in the tax year before making the switch to self-employment, or you’re working multiple jobs. In this case, you may have more than once source of income you’ll need to report on your income tax return.

Read More

Brought to you by TurboTax.com

Taxes for Grads: Do Scholarships Count as Taxable Income?

Heading off to college to broaden your horizons is exciting, but funding your education via scholarships? That's even better. Scholarships often provide a path to education that might not be feasible otherwise, which is why the Internal Revenue Service (IRS) can be generous in minimizing students' tax obligations. But sometimes scholarship money does count as income, and it’s better to find out now if your scholarship adds to your tax liability than to have a surprise later. Here’s how to decode your scholarship taxation.

Read More

Brought to you by TurboTax.com
Read Full Story
Your resource on tax filing
Tax season is here! Check out the Tax Center on AOL Finance for all the tips and tools you need to maximize your return.

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.