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Military Finances 101: What Is the Difference Between a Tax Credit and Tax Deduction?

Taxes

When it comes to preparing your taxes, the idea of tax credits and tax deductions can be music to any military officer's ears. That’s because both are used to lower the amount of taxes someone owes to the government. While they’re both worth getting excited over, it’s important to understand the fundamental difference between these two terms.

What Are Tax Credits?

Simply put, tax credits are reductions on the amount of actual tax owed. Tax credits in no way affect your tax bracket or taxable income. Instead, think of these as reductions that come after the fact - i.e. after you’ve determined how much is owed to the government. There are a few common types of tax credits that can be given based on your income level, whether or not you have children, if you’re a college student and more. These common credits include:

  • Child Tax Credit

  • Other Dependent Credit (added by the Tax Cuts and Jobs Act)

  • Child and Dependent Care Credit

  • Lifetime Learning Credit

  • Adoption Credit

  • Earned Income Tax Credit

Tax credits are typically either refundable or non-refundable. Depending on which type of credit it is, this will affect how much you’ll receive back on your tax refund.

Refundable Tax Credits

Refundable tax credits are tax credits that allow you to be refunded the remaining, unused portion of a credit. For example, say you owe $900 in taxes, but your eligible child tax credit is worth $2,000. Not only will this cover the $900 you owe in taxes, but you will also be refunded the remaining $1,100. It’s important to note that in recent years, certain tax credits (including the child tax credit) have been reformed to include caps on the amount of refundable credit given through the Tax Cuts and Job Acts passed in 2018.1 

Non-Refundable Tax Credits

Alternatively, non-refundable tax credits will only cover the amount in taxes you owe, up to the credit’s limit. If there is more in the credit amount than what you owe, you do not receive the excess amount in the form of a tax refund. For example, if you owe $900 in taxes and your tax credit is worth up to $2,000, the $900 will be covered but you will not receive the additional $1,100.

Changes If You Retire From the Military

If you're getting ready to retire from the military, make sure you check your tax return for some or all of these credits. There is a pretty good chance you won't be able to take them after you retire. That is because all of them have income limits and it is certainly possible that your income could be above that limit.

What Are Tax Deductions?

Tax deductions are used to reduce the amount of income that’s eligible to be taxed. By reducing this amount, your income may fall into a lesser tax bracket, meaning you’re subject to a pay a lesser tax percentage. There are typically two types of tax deductions: itemized deductions and above-the-line deductions.

Itemized Deductions

You can use itemized deductions to help lower your taxable income. Common types of itemized deductions include:

  • Charitable donations

  • Medical expenses

  • Property taxes (including personal property taxes, like vehicle taxes, if your state or county charge them)

  • Mortgage interest


Itemizing your deductions is an "election". That means you can chose to itemize deductions or take the standard deduction. For the 2019 income tax year, these are the standard deduction amounts:

  • Single or married but filing separately: $12,200

  • Married and filing jointly or qualifying widow(er): $24,400

  • Head of household: $18,350

If you don't own a house, in many cases taking the standard deduction will be the better choice.

Above-The-Line Deductions

Above-the-line deductions are used to reduce your adjusted gross income (AGI), which can qualify you for certain itemized deductions and tax credits. Your adjusted gross income is determined by subtracting above-the-line deductions from your gross income. This lower AGI can then allow you to claim important tax credits or deductions that may be dependent on income level. Common above-the-line deductions include:

  • Alimony paid

  • Educator expenses

  • Student loan interest

  • Deductible IRA contributions

  • Moving expenses of armed forces members

Tax credits and tax deductions can both greatly benefit military officers, especially when they work in tandem. Familiarizing yourself with the difference between these two tax terms gives you a great place to start researching and understanding what deductions and credits you and your spouse may be eligible for in the upcoming tax year.

1https://www.congress.gov/bill/115th-congress/house-bill/1/text


If you found this article useful, you might enjoy the following blog posts:

Retired Military Finances 201: Understanding Depreciation Recapture


Military Finances 101: Wash Sales


Military Finances 101: Retirement Accounts



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