Steve’s special guest, Ken Davis, CLU, ChFC, CFP, CPA. Ken Davis is the former president of the Phoenix Chapter of the Society of CPAs and has taught continuing education for the Arizona Society of CPAs on life insurance and annuities.
Tax Credits vs. Tax Deductions
Many fail to see the difference between tax deductions and tax credits. The distinction is important to understand. A tax deduction reduces taxes by an amount equal to your applicable tax rate multiplied times your deduction. For example, a $1,000 deduction at a 28% tax bracket may yield a tax savings of $280. However, a tax credit reduces taxes on a dollar for dollar basis. For example, if you earn a $1,000 credit you may save a $1,000 in taxes.
I use the word “may” in explaining deductions and credits because the tax law sometimes limits the use of these tax savings benefits. And, more of us are now required to use the alternative minimum tax computations which may preclude the use of the deductions or credits. And finally, if the deductions or credits exceed our income, or taxes, we could lose the benefits altogether or be required to carry them back or forward to be used in different time periods.
Just take away the fact that generally credits are much better than deductions, especially for people in low tax brackets. And all that leads me to recommend our second tax tip; accelerate your credits into this year, especially if the tax credits may not be available in future years.
Two tax credits that may be of interest to many of us are residential energy credits and educational credits. These are too complex to cover in detail here so just Google either one or both and you will find plenty of information. In particular the IRS site HYPERLINK "irs.gov"www.irs.gov is a great place to get accurate info that can be used with confidence given it is the IRS’s interpretation of the law!
What is an alternative minimum tax and how can it affect this type of planning?
How does it work?
How does it impact deductions and credits?
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