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Tax Credits And Deductions

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Most people focus on tax deductions when preparing their taxes. It is the most common of terms and understood by just about everyone. If you are new to the process, a tax deduction is simply an amount that you can subtract from your gross earnings. For instance, you might own a small business and drive a lot. The business mileage is deductible, so you should be able to claim a deduction for the mileage times the appropriate rate per mile allowed by the IRS. Once you claim all your deductions, your gross will be reduced to a number called a net profit for businesses or adjusted gross income for personal taxes.

Tax deductions are held up as the great tool for the masses. I scoff at tax deductions. They are helpful, but pale in comparison to the mighty tax credit. Let me make it clear. My tax credit will crush your tax deduction just about any day. Most people fail to look for tax credits when preparing their returns. Heck, many people don't even know what they are. Let's take a look.

A tax credit is a beautiful thing. Why? Well, it is not helpful like a tax deduction when it comes to reducing your gross. It is far more powerful. A tax credit is deducted from the tax you owe. Let that sink in for a minute. It is a dollar for dollar reduction of the amount you determine you have to pay the IRS after figuring out your net profit or adjusted gross income. Let's look at an example.

Assume I suddenly decide to adopt a child. The federal government thinks this is a noble goal and it is going to reward me. I am going to get a tax credit of roughly $10,000 or so. I go ahead and prepare my taxes for the year. After deducting everything legitimate, I end up with my adjusted gross income. I flip over to the tax tables and discover I owe $11,000 to the IRS. Yikes! Wait a minute. I get to deduct my $10,000 tax credit. Now I only $1,000! This is the value of the tax credit.

Tax credits are incredibly powerful ways to knock down your tax liability. Claim as many deductions as you can, but make absolutely sure to claim every tax credit possible.

Tax Credits And Deductions

Every year, the IRS tries to alert people to new deductions and credits available to taxpayers. Some might argue the IRS doesn't make much of an effort, but that is beside the point. In truth, it sends out news releases and so on. Here are some of the areas where you can save on your 2006 taxes that you might not know about.

Telephone Excise Tax Refund ? For the last 108 years, the IRS has collected a long distance tax. Don't remember paying it? Well, this is because your phone service was doing it as part of your bill. Much to the embarrassment of the IRS, the tax has been ruled illegal over and over by courts. The IRS has finally given in. Does this mean you get a refund for the last 108 years? No. Instead, you can claim a $30 or $60 refund on your 1040. The box is line 71 on the 1040 form and line 42 on the 1040A and 1040EZ forms. Alternatively, you can go rifle through your phone bills and file form 8913.

State and Local Sales Tax Deduction ? Mention of this deduction may bring on a sense of d'j? vu. It has been around since 2004, but was set at the end of 2005. Fortunately, it has been renewed. If you itemize deductions, you can choose to deduct the total state and local sales tax instead of the state income tax. This is a windfall for people that made big purchases such as luxury cars or live in a state where income tax is not collected such as Florida.

Home Improvement Tax Credits ? If you installed energy efficient products on your home in 2006, you can claim a nice tax credit. The products, such as windows, doors and appliances, have to be approved for the tax credit. The exact amount of the credit depends on the product, but can be as high as $500. While this may not sound like a lot, keep in mind tax credits are applied directly to the amount you owe the government one you figure out your taxes. This dollar for dollar reduction makes them much more valuable than a mere tax deduction.

As we head full steam into the tax season, most people start to worry about filing their taxes. If you keep the above credits and deductions in mind, it should prove to be less painful.

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