The term “tax break” is a common way to refer to the federal tax credits and deductions you receive on your tax return that change how much you owe in taxes.
Learn what tax breaks are, how they work, and how they benefit taxpayers.
Definition and Example of Tax Break
The term “tax break” isn’t an official one. 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.
- Alternate names: Tax credit, tax deduction
A tax credit reduces how much you need to pay in taxes or may even provide a refund. You can qualify for a tax credit even if you don’t owe any taxes. Tax credits reduce your final tax bill on a dollar-for-dollar basis. For example, if you owed $10,000 in taxes, a $3,000 tax credit would lower what you owe to $7,000.
There are numerous tax credits that you may qualify for across many different categories such as education and health care.
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
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 use of car or home
- Student loan interest payments
- Educator expenses paid by teachers
- Medical or dental expenses
- Contributions to individual retirement accounts (IRAs)
- Capital losses
How Tax Breaks Work
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.
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 reduce the amount of taxable income someone has, which can help them 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.
If you choose to itemize your deductions, you can’t take the standard deduction. It’s worth crunching the numbers on whether or not itemizing your deductions or taking a standard deduction will save you more in the end.
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 ($25,900 for married couples filing jointly). The amount you can deduct may vary based on your age or disability.
- A tax break is a popular way to refer to federal tax credits and deductions because they help you get a “break” on how much you owe in taxes
- A tax credit reduces how much you owe in taxes and may be delivered in the form of a tax refund
- A tax deduction reduces the overall amount of taxable income you have, and it adjusts how much you need to pay in taxes.
- If you itemize your deductions because you want to try for a bigger tax break, you can't take the standard deduction.