Explaining deductions & credits:
Deductions
Deductions can be in the form of adjustments or itemized deductions. Examples of deductions include:
Schedule 1 Deductions
- IRA Contributions
- SEP IRA Contributions - Small Business Retirement Plans
- Educator Expenses
- Health Savings Account Contributions
- Self-Employed Health Insurance Premiums
- Student Loan Interest Deduction
Schedule 1-A Deductions
- Qualified Tips Received
- Qualified Overtime Received
- Enhanced Deduction for Seniors
Form 8895 Deduction
- Qualified Business Deduction for Small Businesses
Itemized Deductions (used when greater than the standard deduction based on filing status)
- Medical Expenses (in excess of 7.5% of Adjusted Gross Income)
- State and Local Taxes (SALT) - up to $40,400 (2026)
- Mortgage Interest
- Charitable Contributions
All of these categories of tax deductions provide significant savings to taxpayers. Here is an example of the tax savings from a deductible expense:
Assuming a taxpayer is in the 22% tax bracket (based on one's taxable income). The taxpayer makes a deductible IRA contribution for the year. His savings would be:
$8000 IRA Deduction
.22 Marginal tax rate
______
$1760 Tax Savings
Total savings from qualifying deductions depends on an individual taxpayer's marginal tax bracket.
Credits
Credits reduce one's tax liability on a dollar-for-dollar basis. This means the amount of the credit is the total tax savings experienced by the taxpayer. It is not contingent of marginal tax rates.
Types of Credits
- Non-refundable
- Refundable
Non-refundable credits do not reduce one's tax liability below $0. Refundable credits can reduce a taxpayer's liability to $0 and any excess credit remaining can be received by the taxpayer as part of a refund.
Examples of credits include:
- Child and dependent care credit
- Child care credit
- Education credits
- Adoption credit
- Earned income credit
Here is an example of how a credit would impact a taxpayer's tax liability:
Taxes owed before credits $4000
Education credit 2500
_____
Total taxes owed 1500
The credit reduced the taxes owed.
Understanding how deductions and credits work are an important part of tax planning. Contact LFC for additional information or help with your tax planning and preparation needs.
