Does a tax deduction lower a person's tax liability?

The tax deduction reduces a person's tax liability by reducing their taxable income. Because a deduction lowers your taxable income, it reduces the amount of taxes you owe, but by decreasing your taxable income, not by directly reducing your taxes. A tax deduction reduces your taxable income, so when you calculate your tax liability, you do so with a lower amount. Basically, your tax liability is reduced by the same percentage as your tax rate.

A tax deduction lowers your adjusted gross income or AGI and, therefore, your taxable income on your income tax return, increasing your tax refund or reducing the taxes owed. Another thing to remember is that you can't apply for a credit and a deduction for the same qualifying expense. Certain types of income, such as parts of retirement income and some academic scholarships, are tax-exempt, meaning they are not included as part of the taxpayer's taxable income. If you are eligible to apply for refundable tax credits, such as the earned income tax credit or the child tax credit, the value of the credit goes beyond your tax liability and may result in a refund check.

Tax filers have the option of requesting the standard deduction or itemizing deductible expenses from a list that includes state and local taxes paid, mortgage interest and charitable contributions. Exemptions and deductions indirectly reduce the amount of tax a taxpayer must pay by reducing their “taxable income”, which is the amount of income on which the taxpayer pays taxes. However, if you are eligible for both a tax credit and a deduction for the same expenses, calculating a few numbers can help you determine which will offer you the greatest reduction when it comes to paying taxes. Taxpayers subtract their credits from the tax they would otherwise owe to determine their final tax liability.

Your ability to qualify for a particular tax credit depends on several factors, including your income, age and marital status to file taxes. A deduction cannot reduce taxable income below zero, so taxpayers lose the value of excess deductions once they reach that limit. Other tax benefits, such as deductions for charitable donations and the payment of mortgage interest, are incentives intended to promote specific social policy objectives. Unlike exemptions and deductions, which reduce the taxpayer's taxable income, credits directly reduce the taxpayer's tax liability, that is, the amount of taxes the taxpayer must pay.

The earned income tax credit, for example, is a refundable credit designed to encourage and reward work, as well as to offset federal payroll and income taxes. If you would like to learn more about personal tax credits, contact your tax advisor or log on to the IRS website at www. In addition, for many low-income filers, the total amount of their deductions is equal to or greater than their income, meaning they have no taxable income.