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Applying of Tax Deductions Instead of Tax Credits

Application Of Tax Deductions And Difference From Tax Credit

Tax deductions are a method of reducing the amount of Federal tax dollars owed by an individual by noting various items that have incurred expenses, though were required in order to earn the individual's income. The various types of tax deduction methods are only available through certain limitations and conditions.

Items in which a business has invested in, such as factory equipment, can earn the business a certain tax deduction allowance over the course of several years as the equipment declines in value and depreciates. Tax deductions are generally divided into business expenses and non-business expenses.

Tax Deduction for the Individual Taxpayer:

Depending on the eligibility of an individual taxpayer, the standard tax deduction or the itemized tax deduction may be chosen. The method chosen generally depends on which method produces the greater amount of tax deductions to benefit the individual.

The standard method is based on a certain dollar amount, which is specific to the filing status of the taxpayer. The itemized deduction requires that certain individual expenses of an individual are noted and deducted off of the taxpayer's adjusted gross income (AGI). All U.S. citizens and resident aliens are eligible for the standard tax deduction.

Also, if a spouse chooses to itemize, then the other spouse cannot choose the standard method. Although the itemized method may provide further benefits, especially for those individuals in higher tax brackets, some individuals may choose the standard method to prevent any adjustments from the Internal Revenue Service from being made not in the taxpayer's favor.

Tax Deduction for Business Expenses:

When businesses are taxed, there are a variety of tax deductions which may be used to reduce the overall amount of taxable income. Tax deductions can be made for any expenses incurred having a direct result of trading goods and services or operation of the business.

Common business expenses which are tax deductible are cost of goods sold (total costs of manufacturing an end product) and trading and necessary business expenses. Although most business expenses are tax deductible, there are limitations on which expenses may be deducted, even if such expenses are related to business operation. These include:

Deductions for the use of automobiles for daily operations;

Limits on tax deductions for compensations given to certain employees;

Limits on tax deductions for entertainment provided by a business;

Payments of criminal fines for violations of public policy.

Tax Deduction for Capitalized Items:

Items that are purchased with the purpose of providing a future benefit to an individual or a business are considered to be capitalized items, and are tax deductible. A capitalized item can be equipment used to manufacture items in a plant and even expenses used to create a patentable invention. Tax deduction is applied to such capitalized items in a process known as depreciation for physical items, and amortization for intangible assets. Depreciation and amortization can be done in a straight line approach at a fixed yearly rate, or by a declining balance.

Tax Deduction for Non-Business Expenses:

Certain systems of tax deduction hold a distinction between assets of a business and assets used to produce an income. Non-business expenses which are tax deductible can include losses on sales or exchanges, though in the United States, losses of non-business assets is considered a capital loss and the deduction is based on the limits of capital gains.

Losses on personal assets in the U.S. are not tax deductible unless it was caused by theft. Taxable income may be reduced for certain types of assets unrelated to business, referred to as itemized deductions. Personal payments in certain jurisdictions can also be deducted, such as alimony, as the payment becomes taxable to the receiver of the payment.

Difference Between Tax Deduction and Tax Credit:

There are two methods in which the amount of money an individual owes to the Federal government can be reduced. It can be done either with a tax deduction or a tax credit. A tax deduction is a way of lowering an individual's taxable income, usually with the purpose of placing the person into a lower tax bracket, requiring less tax money to be owed from the individual.

A tax deduction can be done by figuring out one's adjusted gross income by filling out tax Form 1040. This form is used to discover an individual's adjusted gross income before being placed into a specific tax bracket. Once a gross income is determined on Form 1040, further deductions can be taken from it, either through itemized deductions or standard deduction. The method used for deduction usually depends on the filing status of the applicant, such as married, single, etc.

A tax credit, on the other hand, is a type of credit earned after the tax bracket of an individual is determined, in which case a tax credit is determined and deducted from the actual amount of tax dollars owed. For example, if a person owes $300 and has a tax credit of $50, then the individual will only owe $250 in tax dollars. A tax credit, unlike a tax deduction, is not dependent on a person's annual income, and a tax credit of $100 would be $100 to anyone, no matter how much money is earned in a year by a given person.

Qualifications for Tax Deductions:

Certain tax deductions are not available to everyone. The factors that determine whether or not an individual qualifies for a certain tax deduction usually depends on a person's annual income. If a person makes more than a certain amount of money every year, saving account deductions and others may not be available to that person. Also, expenses that a person would like to deduct from their taxes must be proven to be important to a person's current benefits.

NEXT: How are Charitable Contributions Taxed?

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