A deduction lowers the income your tax is figured on. A credit lowers the tax itself, dollar for dollar. A $1,000 credit is usually worth more than a $1,000 deduction, but which ones you qualify for is a question for your CPA.
What a deduction does
A deduction is an amount you subtract from income before tax is figured. Most of your practice's expenses work this way. Rent, staff pay, supplies and software all reduce the profit you're taxed on.
The deduction saves you your tax rate times the deduction, not the full amount. Spending $1,000 to save tax on $1,000 still leaves you with less money than not spending it.
What a credit does
A credit comes off the tax you owe after it's figured. If you owe $10,000 and qualify for a $1,000 credit, you owe $9,000. Credits tend to have specific rules about who qualifies and what you have to document.
A made-up example
Say your combined tax rate on the next dollar of profit is 30%.
- A $1,000 deduction lowers taxable income by $1,000, which saves about $300 in tax.
- A $1,000 credit lowers the tax by $1,000.
Same $1,000, and the credit saves more than three times as much. That's why credits get so much attention, and why their rules are worth reading closely.
Don't buy things for the deduction
I hear "it's a write-off" a lot. A write-off isn't free. If an expense is good for the practice, the deduction is a bonus. If it isn't, the deduction only softens the cost. Make the decision on the business case first.
How your books help
Deductions depend on expenses being recorded in the right categories, with receipts behind them. Credits often depend on records like payroll reports or proof of a specific purchase. Clean monthly books mean your CPA can find both without a scramble in March. Here's a year-end checklist.
What to ask your CPA
- Which deductions am I most likely missing?
- Are there credits a practice like mine might qualify for?
- What records do you need from me for each one?
Timing matters too
When you pay an expense can change which year it's deducted in, depending on how your books are kept. Prepaying next year's costs in December, or holding off until January, can shift taxable profit between years. That can help or hurt depending on your income in each year, so ask your CPA before you move spending around. Here's how cash and accrual books differ.
What I'd do this week
- Look at last year's return with your CPA's summary of deductions and credits.
- Ask the three questions above.
- Check that your books record expenses in clear categories.
Common questions
Is a credit always better than a deduction?
Dollar for dollar, a credit lowers your tax more. But the two aren't either-or. You take every deduction and credit you qualify for.
Can I claim a credit on my own?
Credits have specific rules and records. Work through them with your CPA before you count on one.
Does a big purchase in December lower my taxes?
It may create a deduction, but you still spent the money. Ask your CPA how it would be treated before you buy for tax reasons.
Want your expenses in the right categories every month?
We reconcile every account every month and send your P&L and Balance Sheet by the 15th, so decisions like this start from real numbers. If that's what you need, apply to work with us.