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Chapter 8: Problem 35

What is the difference between a tax credit and a tax deduction?

Short Answer

Expert verified
A tax credit and a tax deduction both offer savings on your tax bill, but in distinctly different ways. A tax deduction lessens your taxable income, leading to a lower tax liability while a tax credit gives a dollar-for-dollar reduction in your actual tax bill.

Step by step solution

01

Define Tax Deduction

A tax deduction is a certain amount that is subtracted from one's gross income, decreasing the overall taxable income. This is usually eligible for specific expenses, contributions or losses.
02

Define Tax Credit

A tax credit is a dollar-for-dollar reduction of the actual tax bill. It can be deducted directly from the taxes owed, instead of reducing the taxable income.
03

Differentiate Between Tax Deduction and Tax Credit

Highlight the difference in how they affect an individual's tax liability. A tax deduction lowers the taxable income and thus indirectly reduces the tax liability. Yet, a tax credit directly decreases the tax liability, providing higher benefits than a deduction of the same amount.

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Most popular questions from this chapter

You would like to have \(\$ 4000\) in four years for a special vacation following college graduation by making deposits at the end of every six months in an annuity that pays \(7 \%\) compounded semiannually. a. How much should you deposit at the end of every six months? b. How much of the \(\$ 4000\) comes from deposits and how much comes from interest?

In Exercises 11-18, a. Determine the periodic deposit. Round up to the nearest dollar. b. How much of the financial goal comes from deposits and how much comes from interest? $$ \begin{array}{|l|l|l|l|} \hline \$ \text { at the end of every three months } & 3.5 \% \text { compounded quarterly } & 5 \text { years } & \$ 20,000 \\ \hline \end{array} $$

In Exercises 1-10, use $$ P M T=\frac{P\left(\frac{r}{n}\right)}{\left[1-\left(1+\frac{r}{n}\right)^{-n t}\right]} $$ Round answers to the nearest dollar. Suppose that you decide to borrow \(\$ 40,000\) for a new car. You can select one of the following loans, each requiring regular monthly payments: Installment Loan A: three-year loan at \(6.1 \%\) Installment Loan B: five-year loan at \(7.2 \%\). a. Find the monthly payments and the total interest for \(\operatorname{Loan} A\). b. Find the monthly payments and the total interest for Loan B. c. Compare the monthly payments and the total interest for the two loans.

Suppose that you are buying a car for \(\$ 60,000\), including taxes and license fees. You saved \(\$ 10,000\) for a down payment. The dealer is offering you two incentives: Incentive \(\mathrm{A}\) is \(\$ 5000\) off the price of the car, followed by a five-year loan at \(734 \%\). Incentive \(\mathrm{B}\) does not have a cash rebate, but provides free financing (no interest) over five years. What is the difference in monthly payments between the two offers? Which incentive is the better deal?

In Exercises 1-10, use $$ P M T=\frac{P\left(\frac{r}{n}\right)}{\left[1-\left(1+\frac{r}{n}\right)^{-n t}\right]} $$ Round answers to the nearest dollar. Suppose that you borrow \(\$ 10,000\) for four years at \(8 \%\) toward the purchase of a car. Find the monthly payments and the total interest for the loan.
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