Tax credits? Tax deductions? What is the difference? People confuse these terms frequently. Even accounting types do it. So let's clear this up:
Tax credits? Tax deductions? What is the difference? People confuse these terms frequently. Even accounting types do it. So let's clear this up:
Tax Credits
Tax credits are given to companies as incentives for certain kinds of activities, like spending money to improve disability access or for construction of energy-efficient buildings. Tax credits are taken off taxes (adjusted) after income is listed, in order to determine adjusted gross income. So tax credits result in a "dollar for dollar" reduction in your taxes. For every dollar taken off your adjusted gross income, that's one dollar less that gets taxed. As a taxpayer and business owner, you should take all possible tax credits.
The list of possible Business Tax Credits includes:
- Work Opportunity Tax Credit for hiring certain individuals
- Disabled Access Credits, for making your business more accessible
- Credits for using renewable materials in construction or hybrid vehicles in your business
Tax Deductions
A tax deduction, on the other hand, is a legitimate business expense that reduces business income, and thus reduces tax liability. Tax deductions are determined AFTER the adjusted gross income is calculated. For example, a business which sells goods will first determine a net income after cost of goods sold. Then all the business deductions (allowable expenses) are totaled and subtracted from income to get the business profit, or the taxable income.
In conclusion, tax credits and tax deductions are both of benefit to small business owners, because they reduce the taxable income of the business, but tax credits are a little better, because they are a direct "dollar for dollar" reduction.
