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Exemptions, Deductions, Adjustments, and Credits on Your Income Tax Form

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Exemptions, Deductions, Adjustments, and Credits on Your Income Tax Form

Personal exemptions

"Personal exemptions" from income are tax deductions for members of your family. They are based on the number of people and dependents living with you. You declare them on your W-4 form. The number of exemptions that you claim determines how much money is withheld from your paychecks.

Deductions, adjustments and credits

The government offers a wide variety of deductions, adjustments, and credits to lower the amount of income on which you must pay taxes. These are good to have. If you have enough deductions and credits, you can itemize, which involves listing specific information on Schedule A; if not, you can take the standard deduction. The standard deduction is a pre-set amount that reduces the amount that you have to pay in tax; you do not need to gather and list the various deductions if you go this route. For most people, the standard deduction is not only easier to take but also saves more money.

Things To Know

  • Be aware of the deductions and credits available to you.
  • Take the higher of your standard deduction or your itemized deductions.

The only way to determine which course makes sense is to gather all the information and do the calculations yourself through tax preparation software or give it to your tax preparer to determine.

There are also deductions and credits that don’t depend on whether you itemize or not. These are called adjustments. Contributions to IRAs are an example of these.

Deductions and credits, and the difference between the two

Another tax-planning approach is to reduce the part of your income that is subject to tax by taking full advantage of the many tax deductions and tax credits available to both businesses and individuals. Talking with a tax-planning professional is the best way to learn which deductions and credits are available to you. The small business owner, for example, may be able to deduct the cost of meals and entertainment, automobile expenses, and business travel, among many other costs. But there are always special rules that apply to these deductions, so again, the services of a tax professional can be invaluable.

For the moment, keep in mind the difference between a tax deduction and a tax credit. A tax deduction reduces the amount of taxable income you have. A credit reduces the actual tax you owe, within limits, usually dollar for dollar (for example, a one-dollar tax credit reduces your tax bill by one dollar). Sometimes, tax credits are refundable, which means you can, in some cases, get a check from the government if you owe no tax at all. Clearly, tax credits are more valuable than deductions.

Here is a simplified example. Imagine that last year, you earned a total of $20,000: $17,000 in wages and $3,000 in per capita income, and your tax rate was 10%. Normally, that would mean you pay $2,000 in taxes ($20,000 x 10%). A $1000 tax deduction would reduce your income to $19,000. Therefore, you would owe $1,900 in taxes. But a $1000 tax credit would instead reduce your $2000 tax burden to only $1000. Credits, as you can see, save you much more money.