About Me 0074: personal finance blog

As Tax Day draws closer, many are looking for documentation and trying to figure out whether they are taking a deduction or credit for each item that they hope will bring a tax advantage. Understanding the difference between a tax deduction and a tax credit is important — especially when you stop to consider that one is more valuable than the other.

Is That a Deduction or a Credit?

The difference between a tax deduction and a tax credit can be expressed by the way it affects your taxes.

Tax deduction:

This lowers your taxable income. Deductions are taken before your final income is figured out. There are different types of tax deductions. The first is an above the line deduction, which takes place before you figure out your adjusted gross income (AGI). You report your total income, and then subtract your deductions, arriving at your AGI.

The second group of deductions are taken from your AGI. After you have figured out your AGI, you flip over your Form 1040, and begin taking other deductions. You can choose to take the standard deduction, or you can itemize your deductions. Add up what you would itemize (using Schedule A), and see if that number exceeds the standard deduction. You want to choose the larger of your itemized deductions or your standard deduction.

Your second round of deductions are subtracted from your AGI. The result is your taxable income. In many cases, your taxable income is thousands — or even tens of thousands — less than your actual income. A tax deduction helps you by reducing the amount of money that you have to pay taxes on.

Tax credit:

After you have figured out your taxable income, you use that number to see how much you owe in taxes. Your income can be found on the tax table, and that will provide you with how much you owe. Once you know how much money you owe, you subtract the amount of money you have already paid in taxes, including money withheld from your paycheck and money paid in quarterly taxes. Now it’s time to add in your tax credits.

The great thing about a tax credit is that it directly reduces what you owe. This is a dollar for dollar reduction. If you owe $1,000, and you have $500 in tax credits, you only owe $500 total. Having a tax credits is like having a gift card meant to help you pay your taxes.

So, Which is More Valuable?

As you might imagine, having a tax credit is more valuable. A tax deduction is helpful, since it lowers your taxable income, but it isn’t quite the same. Your deduction might not be enough to knock you down a tax bracket, and it simply reduces the amount of money your taxes are figured on. A $100 tax deduction isn’t worth $100, since it might only lower your taxable income from $55,000 to $54,900. That makes a difference of $15 when you go to pay your taxes if you are married filing jointly. (According to the IRS tax table, you would owe $7,416 and $7,401, respectively.)

A credit, though, translates directly into dollars saved. If you have a $100 tax credit, you have a $100 tax credit. It means that if you owe $7,401, and you apply the credit, now you owe $7,301. Of course, if you have already paid your taxes, you could end up with a tax refund. The Earned Income Credit and some other credits can result in the government owing you money after all is said and done.

Recommended Tax Preparation Software: TurboTax | H&R Block | CompleteTax.com

Credit cards have had a bad rap in the press lately; some credit cards have increased their annual percentage rates and some have increased their fees. Most have made at least a few changes to the way they do business thanks to last year’s CARD Act. However, if consumers are responsible with what they charge on their credit cards and are disciplined to pay off their balances each month, there are many benefits to using a credit card.

Airline Miles Credit Cards

If you have excellent credit (above 750), you could earn two airline miles per dollar spent when using the Capital One Venture Rewards Card. When you redeem your miles, there are no blackout dates. For someone who flies frequently and/or uses a credit card frequently, this card may be the way to go. In fact, Money Magazine named it “The best rewards card if you aim to rack up airline miles.” Of course, there are a variety of airline mile cards out there, but be careful as many of them have restrictive rules which make actually redeeming the miles difficult. (See The Best Airline Miles Credit Cards for more airline miles cards.)

Gift Cards Rewards Cards

The US Bank Flex Perks Travel Reward Visa Card allows members to earn one point per dollar spent with a double reward on the one category you spend the most on (between groceries, gas and airline) each month. Redeem 5,000 points for a $50 gift card to restaurants like Outback Steakhouse or for a $50 Visa gift card. These make great gifts during the holiday season and will not cost you anything if you are responsible with using the credit card and use care not to buy more than you would with cash at any given time.

Cash Back Credit Cards

Who wouldn’t like to use their credit card and get rewarded with cash back? Use the Discover More Card and get 1% back on all purchases after you spend $3,000 on the card (before that earn .25% cash back). Also, enroll in the 5% cash back program to receive 5% cash back on designated purchases on designated months. For instance, January through March 2011, earn 5% cash back on up to $800 for travel and restaurant purchases.

Gas Rewards Credit Cards

Offset the rising cost of gas with a card that gives you money back for gas purchases. The True Earnings Card from Costco and American Express gives you 3% back on all gas purchases up to $3000. It also offers 3% back on all restaurant purchases and no annual fee if you are a Costco member.

Credit cards are in the business to make money, but if you are diligent with the way you use your credit card, you may find that credit cards can actually save you money. You can fly for free or at a significant discount, you can earn gift cards that you can use yourself or give to other people for birthday or holiday gifts, you can earn cash back on your purchases, and you can use the card to help offset the rising price of gas. With the right research and self-discipline, you can make credit cards work for you.

The cards mentioned in this article are not endorsed by the writer but are only given as a sample of the many reward credit cards that are available.

Disclaimer: This content is not provided or commissioned by American Express. Opinions expressed here are author’s alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.

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Saturday, March 5, 2011

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