Question

By defining after-tax income, demonstrate the differences resulting from a $500 tax deduction versus a $500 tax credit for a single taxpayer in the 12% tax bracket with $33,000 of pre-tax income.

Answer 1

A $500 tax deduction decreases taxable income. For example, this taxpayer has $33,000 taxable income - $500 = $32,500

Total tax liability = $32,500 x 12% = $3,900

On the other hand, if the taxpayer receives a $500 tax credit, then tax liability = $33,000 x 12% = $3,960

If we apply the tax credit, total taxes owed = $3,960 - $500 = $3,460

The amount of taxes owed decreases significantly more with a tax credit.