What Is a Tax Break?

How Tax Breaks Work

The term “tax break” isn’t an official term. When you hear someone mention a tax break, they’re usually referring to a federal tax deduction or credit, both of which can reduce how much you pay in income taxes. Hence, you’re getting a “break” on your taxes. 

How tax breaks work depend on if you’re dealing with federal tax credits or deductions when you file your tax return. You may even qualify for both tax deductions and credits, which can significantly lower your tax liability.

Tax Credits

You may receive the benefits of a tax credit before or after you file your taxes. In some cases, a tax credit will reduce how much you owe. In other scenarios, a tax credit comes in the form of a refund on your tax return. Either way, these credits help you spend less on taxes. 

Tax Deductions

Tax deductions reduce the amount of taxable income you have, which can help you owe less in taxes. The point of a tax deduction is to avoid taxing income more than once or taxing income that should not be taxed. 

Tax deductions can also help investors reduce their risk. For example, if someone invests money in a stock on January 1st and that stock’s value decreases by December 31st of the same year, the investor can sell the stock and deduct the money they lost.

Itemized deductions, like charitable donations or mortgage interest, require that you provide the IRS with deductible expenses you paid. For most taxpayers, the standard deduction that simplifies the process. 

The standard deduction is generally adjusted annually to account for inflation. In the 2022 tax year, the standard deduction for individual filers is $12,950 and $25,900 for married couples filing jointly. The amount you can deduct may vary based on your age, too.

Examples of Tax Breaks

These are some examples of tax credits:

• Child tax credit and credit for other dependents
• Residential energy efficient property credit
• Premium tax credit
• American Opportunity Credit and Lifetime Learning Credit
• Foreign tax credit

So, if you owed $4,000 in taxes and you had a $1,500 residential energy efficient property credit, you'd only owe $2,500.

A tax deduction, on the other hand, reduces the overall amount of income used to determine how much you owe in taxes. So, if you earned $50,000 and deducted $15,000, you’d be taxed on $35,000 of income instead of $50,000. This would lower the taxes you’d owe or, in some cases, increase your refund.

Here are a few examples of tax-deductible expenses:

• Business expenses, such as the use of a car or home
• Student loan interest payments
• Educator expenses paid by teachers
• Medical or dental expenses
• Contributions to individual retirement accounts (IRAs)
• Capital losses
  

Frequently Asked Questions (FAQs)