A tax cut and a tax credit allow you to pay a lower tax amount. A credit and a cut work differently, though. For example, you usually claim a credit on your federal income tax return. A tax cut usually refers to the amount of taxes deducted from a paycheck or refers to the percentage of taxes you pay based on your income.
The IRS defines a tax cut as a reduction in the amount of taxes the government takes. For example, a tax cut occurs when the government decides to reduce the tax rate from 15 percent to 10 percent. The IRS defines a tax credit as "dollar for dollar reduction in the tax." The credit can be taken out of the amount of tax a person owes. For example, if someone owes $850 in taxes and qualifies for a $1,000 credit, he will actually receive $150 back if it is a refundable credit.
Tax Cut Example
The payroll tax cut serves as a good example of a tax cut. Usually, employed people in the US need to pay 6.2 percent of their income as Social Security tax. The number doubles for people who are self-employed, as they are both the employer and employee. The amount of the payroll tax was reduced to 4.2 percent in 2011, and then again in 2012. The cut allows people to take home more money each pay period or to pay less in taxes over the course of the year. According to Susanna Kim of ABC News, a family who earns $50,000 will take home an extra $85 per month with the tax cut.
Tax Credit Example
The Retirement Savings Contribution Credit is an example of a tax credit. This credit is only available to people who earn less than a certain amount over the course of the year. At the time of publication, the amount is $28,250 for a single person. To claim the credit, a person needs to contribute to a retirement plan such as a Roth IRA over the course of the year and complete Form 8880 when she files her taxes. The maximum credit amount is $1,000 for single people and $2,000 for married filing jointly.
Refundable Vs. Nonrefundable Credits
Some credits allow a person to receive money back if the credit is worth more than he owes in taxes. Other credits can only be deducted from taxes until the amount of taxes owed reaches zero. For example, the Lifetime Learning Credit is a nonrefundable credit. If a student can claim a credit of $2,500 but only owes $2,000 in taxes, he can only claim a credit of $2,000. Refundable credits include the earned income tax credit. Nonrefundable credits include the retirement credit, adoption credit and education credits.
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