Solving your Tax Needs For Years
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The tax code provides several ways to control your tax bill through deductions and credits. Tax deductions allow you to reduce your taxable income, and tax credits allow you to directly reduce your tax liability.
When you make income from a job, you can often reduce your taxable income by contributing to an employer-sponsored retirement plan or your own individual retirement account (IRA). You may also have a high deductible health plan through your employer with access to a health savings account (HSA) or flexible spending account (FSA).
Almost everyone qualifies for the standard deduction or itemized deductions that reduce your taxable income. These are often the largest deductions available to you. Refer to item 6 below for information on which one might be best for you.
Self-employed workers and business owners may have more opportunities to save on their tax bills, but employees still have plenty of savings opportunities available. As an employee, you can deduct contributions made to IRAs, HSAs and FSAs when preparing your Form 1040.
All things being equal, a tax credit is often preferable to a tax deduction. Tax credits reduce your tax liability dollar for dollar while tax deductions lower your taxable income. For example, if you prepare your taxes and have a total tax bill of $10,000, a $1,000 tax credit would reduce your bill by that amount.
If you had a $1,000 tax deduction and earned $50,000 in taxable income, your income tax liability wouldn't decrease by $1,000. Instead, your taxable income would now be $49,000. Depending on your tax bracket, that means you would save anywhere from $0 to $370 as compared to $1,000 from a tax credit.
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