Tax Credits vs. Tax Deductions
Understanding all the nuances of taxes can prove difficult for anyone who’s not a CPA or tax professional. However, having limited knowledge of what is likely your #1 expense in life can mean you’re burning precious cash that could be better spent by you, your business, and your family.
There is one key distinction that I hope to simplify for you: the difference between tax credits and tax deductions.
What purpose do they serve? How are they similar? How are they different? And how can they benefit you and your business?
Tax credits and tax deductions are similar in that they both serve to reduce the amount of taxes that you are ultimately required to pay. However, they accomplish that same goal in very different ways. A tax credit is a dollar-for-dollar reduction of the taxes you owe, while a tax deduction only reduces your taxable income by a certain percentage according to your tax bracket.
Simply put, a tax credit will decrease the total amount of taxes that you are required to pay, while a tax deduction only decreases the amount of taxable income that you’re claiming.
Tax credits can save you significantly more than tax deductions can, as they are accounted for prior to your gross income being determined. In addition, tax deductions become more valuable as your income and tax bracket increase. For example, in a 15% tax bracket, every dollar of deductions reduces your tax burden by 15 cents, the 32% tax bracket by 32 cents, the 35% tax bracket by 35 cents, and so on. All this while tax credits would reduce your tax burden by their full amount; be it a $5,000 credit or a $50,000 credit.
How does this play out in practice?
Suppose you are in the 24% tax bracket. If you are eligible for, and receive, a tax credit of $10,000, your tax burden would be reduced by a full $10,000. However, if you claim $10,000 in deductions, your tax burden would only be reduced by $2,400. Clearly, tax credits are much more beneficial to the taxpayer.
Let’s review.
Tax credits are subtracted from your income BEFORE your gross income is settled, while tax deductions serve to reduce your net taxable income. A tax credit will also decrease the total amount of taxes you ultimately have to pay, while a tax deduction only decreases your taxable income. Therefore, claiming a tax credit will most often result in a much smaller overall tax liability than just claiming a tax deduction.
If you’re tired of overpaying taxes and feel like you don’t have an answer for your ever-growing tax bill, we need to talk. I work hand-in-hand with my client’s CPA(s) to ensure that both the business and the business owner are maximizing the tax credits available to them and minimizing the amount that they have to shell out to Uncle Sam. My team specializes in working synergistically with your financial professional(s) to handle all the heavy lifting so you, the business owner, can focus on doing what you do best, running your business! You can leave all the minutia of taxes and number crunching to your CPA and our knowledgeable team.
Also, if you haven’t heard of, or taken advantage of, the ERC or R&D Tax Credits, reach out to me directly, and we will see if your business is a fit to qualify for either or both of the credits.
Here’s to your continued success 🚀
