Tax Credits and Deductions Can Save You Money—Here’s How

Completing a tax return can be complicated. For many of us, getting it over with quickly is the goal. But taking a little extra time can potentially make a big difference.  

Learning about deductions and credits, for example, might help lower your tax bill. While the end result of claiming a deduction or a credit is the same—more money in your pocket—they get you there in different ways. When you’re filling out your income tax return for 2021, it’s a good idea to understand how they work.

How you can benefit from tax credits
Tax credits lower your tax bill, dollar for dollar. For example, if you’re eligible for a $1,000 tax credit and you owe $4,000 in taxes, the credit would reduce your tax liability by $1,000, making it $3,000. Your ability to qualify for a specific tax credit depends on factors like your income, age and tax filing status.

Some tax credits are refundable, meaning they can be claimed even if you owe zero in taxes. In that case, if you qualify for a $1,000 refundable tax credit, you could receive a $1,000 refund.

You may be able to claim one or more of these credits:

• Saver’s Credit—Equal to a percentage of your contribution to your employer-sponsored plan up to $1,000 ($2,000 if married filing jointly) based on your income. The Saver’s Credit is nonrefundable.
• Earned Income Tax Credit (EITC)—Depending on your income level, you could be eligible to claim the refundable EITC. The EITC is a refundable credit.
• Lifetime Learning Credit (LLC)—A credit for up to $2,000 for certain tuition and education-related expenses for yourself or a family member. The LLC is nonrefundable.
• Residential Energy-Efficient Property Credit—As a homeowner, making your home more energy efficient can qualify you to deduct what you spend. The residential energy credit is nonrefundable.
• Child and Dependent Care Credit—This credit helps to offset the cost of child care or taking care of an elderly parent. This credit may not be refundable.
• Premium Tax Credit—For people who purchased health insurance through the federal marketplace. The Premium Tax Credit is refundable.

Deductions lower your taxable income
Tax deductions do not directly lower the amount of taxes you pay. Rather, deductions allow you to reduce the amount of your income that is subject to tax. Deductions can be based on interest payments on your home mortgage, or expenses like healthcare costs, retirement plan contributions and others. There are two ways to claim them: standard or itemized.

When and how to itemize deductions
For this approach, you list individual expenses to write off on your return. If they’ll add up to a higher amount than the standard deduction, it may be worth it. Here are some of the expenses you may be able to deduct for tax-year 2021:

• Charitable donations
• Mortgage loan interest
• Contributions to a traditional IRA
• Contributions to health savings accounts (HSAs)
• Property taxes

Most taxpayers take the standard deduction  
For 2021, the standard deductions are $25,100 for married people filing jointly, $18,800 for those filing as head of household, and $12,550 for single and married individuals filing separately. Going this route may be easier since you won’t have to add up deductible expenses on your own. You can claim the standard deduction on IRS Form 1040.

What’s the best way for you?
Some people think tax credits are better than deductions because they directly reduce the amount of tax you owe. If you’re eligible for both a tax credit and a deduction for the same expenses, it’s worth comparing the benefits to make sure you’re getting the biggest possible tax break.

A tax professional or tax-preparation software can help you figure out what works best for your situation. If you decide to complete the paperwork entirely on your own, be sure to check out the IRS website to learn which credits and deductions you qualify for.  

The tax information contained herein is for informational purposes only. You should consult your financial adviser or attorney regarding your individual circumstances.