How a Tax Credit Works

Published on: 12:40PM Mar 29, 2010
On our post regarding the Ag Security Credit, we had a reader leave the following comment:
$50,000 spent x 28% tax rate = $14,000 tax = $1,000. Next year $15,000 income from credit x 28% tax rate = $4,200 = $3,000 loss on all the extra paper work. Will the credit need to be included as income on next years taxes?
Here is how the actual income tax effect would work for the current year.

If you spend $50,000 on chemical related expenses, you get a credit of $30% or $15,000.  Let's also assume you are in the 28% bracket.  The remaining amount of $35,000 times 28% equals $9,800.  Therefore, your tax savings for the current year are $24,800 which is greater than the deduction savings of $14,000 ($50,000 * 28%) by about $11,000.

The reader assumes that the credit is included in income in the next year's tax return.  Almost all business tax credits are not reported as income.  An exception is for the fuel tax credit (which is technically not a business credit).  Therefore, assuming you have a enough income to offset the credit, the credit is a 100% reduction in your tax while a deduction only reduces your tax based upon your overall tax rate.

This means we almost always want to get a credit versus a deduction.