Do you understand the difference between a tax reduction and a tax credit? This story should explain the difference. A self employed customer ( let’s call her Debbie ) came to me to prepare her tax return. She was quite upset as she had a balance due of $400.

She could hardly stand the idea of paying the governing body any additional money. “After all”, she revealed, “I’ve already paid them many thousands dollars! Isn’t that enough! They do not merit another dime of my cash, so I am going to go back home and check my records another time to work out if I can find some more deductions.” I was considerate to Debbie and could definitely understand her disappointment.

It does appear arbitrary a taxpayer pays in thousands of greenbacks in the year, and then she needs to turn around and write another check on Apr fifteen for another $400. And Debbie had the right angle about finding more reductions. I’m sure that many taxpayers leave a large amount of cash on the table when they do not take all of the rebates they’re legally entitled to. So I commended Debbie on her resolution to find some more rebates to lower her $400 balance due. On her way out the door, Debbie announced : “I know I can find another $400 worth of refunds. I’ve got some invoices that I did not bring in yet, and if those bills total up to $400, I can feel far better if I just ‘break even’ rather than paying the IRS more money.” I whizzed over to the door to stop Debbie from leaving my office. “What do you mean, ‘If those bills total up to $400 I should break even’?” I asked. “Well,” expounded Debbie, “Don’t I just have to find another $400 in repayments to reduce my tax liability down to zero?” “Sit down, Debbie. We want to have a little discuss before you go.” I proceeded to inform Debbie that finding another $400 in rebates wouldn’t reduce her tax by $400. Instead, that extra $400 in discounts would only reduce her taxable revenue by $400. How much exact tax she would save wouldn’t be $400. Debbie was confusing a tax reduction with a tax allowance. To find out how much tax savings would result from a $400 reduction needed another calculation.

And to do that calculation, she had to grasp what her tax rate was. It turns out that Debbie was in the 25% Tax Bracket. To paraphrase, the highest Tax Rate % that she paid on her earnings was 25%. So, if she reduced her Taxable Earnings by $400 of extra refunds, her tangible tax savings would be : $400 x 25% = $100. She would save $100, not $400. Debbie was startled. “You mean I must have more than $400 in rebates to save $400 in taxes?” “That’s right,” I claimed. “To scale back your taxes by $400, you want an extra $1,600 in deductions.” I took out a piece of paper and put down the following calculation : $1,600 x 25% = $400. Debbie was now upset once more. “There’s no way I will come up with that quantity of kickbacks. I believe I should just have to pay.” “Well, go forward and find whatever discounts you can. Then you can figure out your tax savings by doing this easy multiplication problem : Reduction Amount Times Your Tax Rate of 25% Equals Your Tax Savings.” to paraphrase, since Debbie was in the 25% Tax Bracket, all she had to do was multiply her reduction amount by her Tax Rate % to work out her tax savings.