It's officially the end of tax season, so you might want to get a move on if you haven't already. Even if you've only dipped a toe into the filing process, you might already be considering which credits and deductions you qualify for. Owing less and getting a big refund sounds good no matter which process you use, but are you 100% sure you know the difference between credits and deductions?
Owing money on your taxes is an unfortunate reality for a lot of folks out there, though it isn't the norm, statistically speaking. Based on data from filings last year, Bankrate reported that 64% of taxpayers, nearly two-thirds, ended up with a refund rather than a tax due. Where you end up can depend on how much you opted to withhold during the year, and what sort of work you do. For most of my career, I've gotten W2s and had income tax withheld from each paycheck, so I tend to end up with a refund. A lot of my friends, however, have done freelance, contracted or self-employed work, which means they tend to owe a lot come tax season.
It doesn't matter how you get there, because credits and deductions can end up helping you out no matter what -- as long as you know how to use them properly.
Keep reading for everything you need to know about these systems and how they differ. For more tax season tips, check out how to track your state tax refunds.
What is a tax credit?
You can claim a tax credit while filing your return if you meet the right criteria, and by doing so, you can lower your tax due and, in some cases, increase your refund amount. Some popular examples include the child tax credit, the dependent care credit and the retirement savings credit. Some of these are simple to qualify for -- for instance, you only need to have a kid under a certain age that meets certain tax dependent standards to get the child tax credit -- while others can be more complex, so make sure you do your due diligence.
Say for example, you report all your income and, even factoring in your taxes already withheld, you end up owing Uncle Sam $1,500 (maybe you owe $6,000 in total, but had only $4,500 withheld from your paychecks), and then you claim a credit that's good for $600. In this case, your tax due would drop to $900.
When is a tax credit refundable?
Most of the time, you'll probably find that any given tax credit is "nonrefundable," meaning that it can only decrease your tax due closer to $0. Once you owe nothing, it can't keep going and increase the amount of your tax refund. The example I gave above would be possible with a nonrefundable credit.