Tax deductions and credits

Question

Deomonstrate the differences resulting from 1000 tax credit versus a 1000 tax deduction for a single taxpayer in the 25 percent tax bracket with 40,000 of pre tax income

Answer 1

I know this question is dated but another student may need the same assistance in the future so here it goes.

 

Tax credits provide a dollar-for dollar reduction of your income tax liability.

 

Taxable income = $40,000

25% Tax rate = 10,000

Tax credit = $1,000

Tax liability = $9,000

 

Whereas tax deductions lower your taxable income.

 

Taxable income = $40,000

Tax credit = $1,000

Adjusted Gross Income = $39,000 

25% Tax rate = 9,750
Tax liability = $9,750

 

Another way to look at it is, tax deductions are ABOVE the line deductions (meaning above AGI); whereas tax credits are BELOW the line deductions.