What is the difference between a tax DEDUCTION and a CREDIT?

When April rolls around every year, we start hearing all about deductions and credits to our taxes. Do you know the difference? Deductions generally arise from expenses you incur throughout the year. Deductions reduce your taxable income. Credits, on the other hand, reduce your tax expense directly, dollar for dollar. Because of this, if someone were to ask you, "which would you prefer: a $1,000 deduction or a $1,000 credit on your upcoming taxes?"...your answer would be "CREDIT PLEASE!" Credits are always more valuable on a relative basis. A very quick and dirty example to illustrate this is... ...let's say you made $9,000 last year and are in the 10% marginal tax bracket (note: this example is over simplified for educational purposes). That means you owe $900 ($9,000 X 10%) to Uncle Sam. Now, what will be better for you: a $1,000 deduction or a $1,000 credit? A deduction means we lower our taxable income by $1,000, leaving us with $8,000 to be taxed at 10%. That deduction lowered our tax expense to $800 for the year ($9,000 of income minus the deduction of $1,000, times the tax rate of 10%). On the other hand, a $1,000 credit simply reduces our tax expense already calculated, dollar for dollar, or $900- $1,000 credit for a refund of $100! Woo-hoo! Don't thank us though, we can't take all the credit ;)

-Your Friends at Red Oak Financial Group