Is It Better to Have a Tax Credit or a Deduction?

People often say that an expense is “a tax write-off”; most everyone interprets this to mean that the expense will have a tax benefit. Generally, such a benefit takes the form of either a deduction or a credit; these benefits’ effects are quite different, however, and each type has various categories. As a result, the tax implications may not be as expected. This is especially true when the write-off claim comes from a salesperson who is touting the tax benefits of a product or service, as such individuals often leave out key details. In general, a deduction reduces taxable income, whereas a credit reduces the tax itself.

Article Highlights:

• Itemized Deductions
• Above-the-Line Deductions
• Business Deductions
• Asset-Sale Deductions
• Refundable Credits
• Nonrefundable Credits
• Carryover Credits
• Business Tax Credits

People often say that an expense is “a tax write-off”; most everyone interprets this to mean that the expense will have a tax benefit. Generally, such a benefit takes the form of either a deduction or a credit; these benefits’ effects are quite different, however, and each type has various categories. As a result, the tax implications may not be as expected. This is especially true when the write-off claim comes from a salesperson who is touting the tax benefits of a product or service, as such individuals often leave out key details. In general, a deduction reduces taxable income, whereas a credit reduces the tax itself.

Tax Deductions – In one way or another, tax deductions reduce the taxable portion of an individual’s income, which thus reduces the tax on that income.

Itemized Deductions – When taxpayers think of deductions, they typically think of the itemized deductions that are claimed on Schedule A. This is the only way to deduct personal expenses such as medical costs, state and local tax payments, investment and home-mortgage interest, charitable contributions, disaster-casualty losses, and various rarely encountered expenses. In some cases, itemized deductions are limited. For instance, medical expenses are only deductible to the extent they exceed 10% of the taxpayer’s adjusted gross income (AGI). Similarly, state and local tax payments (including those for income, sales, and property taxes) are capped at $10,000. On top of that, itemization only reduces taxable income to the extent that the total of the itemized deductions exceeds the standard deduction. When the sum does not exceed the standard deduction, the itemized deductible expenses provide no tax benefits at all.

Above-the-Line Deductions – Certain deductions actually reduce income. These are commonly called above-the-line deductions because, when applied, they reduce the income figure that is used to calculate AGI. Thus, their benefits apply regardless of whether the taxpayer uses itemized deductions. Above-the-line deductions include educators’ expenses; contributions to health savings accounts, traditional IRAs, and certain qualified retirement plans; deductible alimony payments; and student-loan interest. Most of these deductions have annual maximums.

Business Deductions – Taxpayers who operate noncorporate businesses can deduct from their business income any expenses that they incur when operating their businesses. These deductions (which cover advertising fees, employee wages, office-supply costs, etc.) are used to reduce profits, which in turn reduces taxable income and, ultimately, income tax. In addition, most self-employed taxpayers pay Social Security and Medicare taxes on their net business income, so any reduction in their business profits also reduces their Medicare taxes and possibly their Social Security taxes.

Asset-Sale Deductions – An individual who sells an asset is allowed to deduct that asset’s cost from the sale price to determine the taxable profit. Good recordkeeping is helpful here because the original expense may have been incurred years prior, even though it is only deductible when the asset is sold. For example, any improvements that an individual makes to a home over years of ownership are not deductible until the home is sold. At that point, the individual can reduce the taxable gain from the sale by counting the improvements as part of the home’s cost.

       Tax Credits – Tax credits come in several varieties, and the amount of benefit can vary:

Refundable Credits – A refundable credit offsets current tax liability; it is so called because any amount of unused credit is refunded to the taxpayer. Refundable credits include the Earned Income Tax Credit, the Additional Child Tax Credit, and the Premium Tax Credit (net of any advances received), as well as the American Opportunity Tax Credit (an education credit that is 40% refundable). As a matter of general interest, these credits are subject to significant filing fraud because of their refundability. The IRS also considers prepayments such as income-tax withholding and estimated tax payments to be refundable credits.

Nonrefundable Credits – A nonrefundable credit only offsets tax liability; any unused amount is lost (unless it can be carried over to another year; see below). Over time, Congress has become more generous with credits; most credits that are not refundable now carry over for a given period. Nonrefundable credits include the Saver’s Credit, the Lifetime Learning Credit, and the personal portion of the Electric Vehicle Credit.

Carryover Credits – For some nonrefundable credits, any unused current-year credit can be carried over to the next tax year (or for a longer period) until the carryover amount is used up. These credits include the Adoption Credit (which can carry over for up to five years) and the Home-Solar Credit (which carries over through at least 2021; tax law is unclear on whether it will expire then).

Business-Tax Credits – Numerous business-tax credits are available; however, they are grouped into the General Business-Tax Credit, which is nonrefundable but which carries forward for twenty years and back for one year. (This allows a business owner to amend the prior year’s return so as to claim the credit.) This category includes the business portion of the Electric Vehicle Credit.

If you have questions related to how you might benefit from tax credits or deductions, please call this office or visit our website.

Employer-Offered Benefits That Can Save You Money and Taxes

Tax law includes a number of tax- and financially favored benefits that employers can offer or provide to their employees. This article is intended to make you aware of these perks, with the caveat that all employers, especially small businesses, may not provide all, or perhaps any, of these covered perks. But whichever of these benefits your employer offers, you should seriously consider taking advantage of them, if you haven’t already.

Article Highlights:

• Health Insurance
• Retirement Plans
• Qualified Transportation Fringe Benefits
• Flexible Spending Accounts (FSAs)
• Group Term Life Insurance
• Qualified Employee Discounts
• Employer-Provided Education Assistance
• Adoption Expenses
• Child and Dependent Care Benefits
• Health Savings Accounts

Tax law includes a number of tax- and financially favored benefits that employers can offer or provide to their employees. This article is intended to make you aware of these perks, with the caveat that all employers, especially small businesses, may not provide all, or perhaps any, of these covered perks. But whichever of these benefits your employer offers, you should seriously consider taking advantage of them, if you haven’t already.

Health Insurance – For a company that has 50 or more employees, the Affordable Care Act (aka Obamacare) requires the business to offer at least 95% of its full-time employees and their dependents (but not spouse) with affordable minimum essential health care coverage or be subject to a penalty. If you work for one of these larger employers and the company picks up the entire health insurance premium cost, consider yourself lucky, as the costs of health insurance coverage have risen dramatically over the last few years. More likely, you may have to pay part of the premium costs, and the plan may have a high deductible and/or co-pays. Even so, the tax-free benefit of what the employer covers is valuable. While not required to, businesses with fewer than 50 employees may offer health care coverage, often for competitive purposes in retaining employees. The health insurance premiums paid on your behalf by your employer are tax-free to you. If you aren’t aware of the value of this nontaxable employee benefit, you can look at your Form W-2, box 12a, code DD, which shows your share of the cost of employer-sponsored health coverage. You can claim the part of the coverage that you pay for with post-tax dollars as a medical expense, if you itemize your deductions.

Retirement Plans – Although some larger employers may provide a company-funded retirement plan that will pay you a monthly benefit when you retire, most generally offer 401(k) plans with which an employee can save for retirement by making pre-tax contributions up to $19,000 for 2019. and if the employee is age 50 or over, they can qualify to make a catch-up contribution of up to $6,000, bringing the total to $25,000. Some employers also match their employees’ contributions up to a certain amount, which means an employee should endeavor to contribute at least the amount that the employer will match.

Qualified Transportation Fringe Benefits – Certain transportation-related fringe benefits that an employer may provide to employees are tax free to the employee. Prior to the passage of the tax reform in late 2017, employers were able to provide employees with tax-free reimbursement for parking, transit passes, commuter transportation, and bicycle commuting, subject to certain limits, and the employer could deduct the cost. The tax reform had a significant impact on these benefits. It eliminated the $20-per-month bicycle benefit and no longer allows the employer to deduct reimbursements made to employees for other transportation benefits, making some employers less likely to offer any transportation fringe benefits. However, they remain tax-free to the employee; for 2019, the limit on tax-free employer reimbursements is $265 per month each for qualified parking, transit passes, and commuter transportation.

Flexible Spending Account (FSA) – This is a special account established by an employer that allows employees to contribute to the account through salary-reduction contributions. The benefit is that the contributions are pre-tax, meaning the employee doesn’t pay taxes on the money contributed to the account. This allows employees to pay for certain out-of-pocket health care costs with pre-tax dollars. The health care expenses can be used for health plan deductibles, co-payments, and even some over-the-counter-medications. The annual limit on contributions is inflation adjusted and is $2,700 for 2019. However, if you don’t use the money in your FSA, you’ll lose it.

Group Term Life Insurance – The cost for the first $50,000 of group term life insurance (GTLI) coverage provided by an employer is excluded from the employee’s taxable income. However, the employer-paid cost of group term coverage in excess of $50,000 is taxable income to the employee, even if he or she never receives it (i.e., it is “phantom income”). So, while the tax-free coverage of the first $50,000 is a good perk, an employee shouldn’t automatically sign up for more than $50,000 of GTLI coverage without considering whether they truly need the coverage and what the extra cost will be. In some cases, an employee who wants more than $50,000 in coverage may be able to privately acquire a policy that will cost less than the tax on the imputed income for the extra coverage through the employer’s plan.

Qualified Employee Discounts – A certain amount of an employee discount on purchases from an employer or on services provided by an employer is excludable from the employee’s income. The exclusion is limited to the employer's gross profit percentage for property, or 20% of the price at which the employer sells services to non-employee customers, for services.

Employer-Provided Education Assistance – An employee doesn’t have to include, in his or her income, amounts paid by the employer for educational assistance under a qualified education-assistance program. The maximum amount of educational assistance that an employee can exclude is $5,250 for any calendar year. Excludable assistance under a qualified plan includes, among others, tuition, fees, books, supplies, and equipment. The education is any training that improves an individual’s capabilities, whether or not it is job-related or part of a degree program.

Adoption Expenses – An employee may exclude amounts paid or expenses incurred by the employer for qualified adoption expenses connected to the employee’s adoption of a child, if the amounts are furnished under an adoption-assistance program in existence before the expenses are incurred. If the adopted child is a special needs child, the exclusion applies regardless of whether the employee actually has adoption expenses. The maximum exclusion amount is inflation adjusted annually and is $14,080 for 2019 per child, for both non-special needs and special needs adoptions. The exclusion is phased out when the employee’s modified adjusted gross income is between $211,160 and $251,160 for 2019. Taxpayers can claim a tax credit for qualified adoption expenses, subject to the same phaseout range as for the exclusion, but any excludable employer-paid expenses can’t be used for the credit.

Child and Dependent Care Benefits – Qualified payments made or reimbursed by an employer on behalf of an employee for child and dependent care assistance are excluded from the employee’s gross income. The amount of the exclusion is limited to the lesser of $5,000 ($2,500 for married individuals filing separately), the employee’s earned income, or the income of the employee’s spouse. A child and dependent care tax credit is available to taxpayers, but no credit is allowed to an employee for any amount excluded from income under his or her employer’s dependent care assistance program.

Health Savings Accounts – Employees who have a high-deductible health plan through their employer can open a health savings account (HSA) and make annually inflation-adjusted pre-tax contributions, which, for 2019, can be up to $7,000 for families and $3,500 for a single individual. When distributions are made for medical expenses, the money comes out tax-free. However, distributions not used to pay qualified medical expenses are taxable, and if the plan’s owner is under the age of 65, nonqualified distributions are subject to a 20% penalty. Some individuals let the account grow and treat it as a supplemental retirement plan, waiting until after age 65 to begin taking taxable but penalty-free distributions.

If you have questions on how job-related benefits might apply to you or if you are an employer interested in providing any of these benefits to your employees, please give this office a call or visit our website.