So many people, even those who do their own taxes, don't really understand the basics of taxes. Today, a very brief overview of one small piece of tax filing that is frequently misunderstood.
What is the difference between a credit and deduction?
Credits are a direct dollar-for-dollar reduction of an individual's tax liability. There are two different types of credits: non-refundable and refundable.
Non-refundable credits can reduce the amount of tax owed to $0, but cannot increase the amount of a refund. (Examples: child tax credit, retirement savings contribution credit.) Refundable credits, on the other hand, can reduce the amount of tax owed and, once your tax liability has reached $0, contribute to your tax refund. (Examples: Earned Income Tax Credit!)
Deductions are amounts that are subtracted from a person's adjusted gross income to arrive at the taxable income. It reduced's an individual's tax liability in proportion to his or her tax bracket.
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