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The beginning of 2008 is a time to reflect on the previous year and plan for the future, which is a fun and inspiring thing to do. However, it is also that time of year when you have to start paying your taxes as part of your planning. The first step is to prepare for it, and that includes understanding the difference between a tax credit and tax deductions.

The simple explanation is that deductions lower your taxable income and credits lower your taxes. An example of a deduction would be charity donations. If taxpayers donate cash or property to qualified non-profit organisations, especially a sizeable amount, these are tax deductible. Which means you can apply for the money back on your forms.

Home mortgage interest can also be deductible from tax. On the Form 1040, Schedule A, the mortgage interest is reported. Here you can also find a list of other types of items that can be deducted from.

Items that are deducted affect a taxpayer’s income tax. The amount is subtracted from a gross income, from which the taxpayer computes his or her income taxes. This has a chain reaction on the overall taxable income, ultimately lowering it. The amount of tax payment saved is dependent on the tax rate, which is where it can start becoming a bit complicated.

Tax credit is similar but it is not dependent on the rate the taxpayer pays. It reduces the tax paid, amount per amount. There are two different types of tax credit. The first is recognition of partial payment already made towards taxes due. The second describes a state benefit, which is paid to employees through the tax system. The latter has an effect of increasing net income.

An example of a tax credit is a Working Tax Credit in the UK. This is for people who are employed or self-employed with children. You must work 16 hours or more a week and expect to work for at least 4 weeks. You have to be 16 years of age and responsible for at least one child, aged 16 and disabled or aged 25 or over and work 30 hours a week.

Every country has a different system of tax credits and deductions for taxpayers to choose from. It is advisable to check them when filing your forms, as there are a fair amount of deductions and credits that taxpayers forget about and don’t apply for. For example, taxpayers can apply for a student loan interest deduction, tuition and fees deductions and even moving expenses.

You might think that the total isn’t much, but if you add it up here and there, it works out to be a large sum of money. Plus it is your money and you have a right to apply for it, if it is applicable. The process has been designed to be simple, and most taxpayers are able to go to their local tax website for information, forms and help on the matter.

Celeste writes for Capital Consulting, who specialise in Offshore Tax.

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Tags: Offshore Tax, Tax Deduction, irs, tax, Tax Credit

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Tags: Capital Consulting, irs, Offshore Tax, student loan, tax, Tax Credit, Tax Deduction