Pop Quiz!—Tax Planning Basics
Q: What’s the difference between a tax credit and a tax deduction?
A: A tax credit reduces your tax dollar for dollar—that is, a $1,000 tax credit actually saves you $1,000 in taxes. By comparison, a tax deduction reduces your taxable income, but is only worth the percentage equal to your marginal tax bracket. The higher your tax bracket, the more a deduction is worth, but a credit is always worth more than a dollar equivalent deduction.
Q: What does basis mean?
A: Basis is the starting point for determining gain upon the disposition of any asset. In its simplest form, basis is your investment in the asset. For purchased property, starting basis is the original price paid. Basis can be increased (e.g., by making improvements) or decreased (e.g., after a casualty loss), and can change according to how the asset was acquired and the nature of the eventual disposition.
Q: What is a marginal tax rate?
A: The marginal tax rate is the rate applied on your last dollar of earnings. For instance, assume an imaginary tax system with two rates: Income up to $10,000 is taxed at 5 percent and income in excess of $10,000 is taxed at 10 percent. If you earned $15,000 and received a $1,000 bonus, your marginal tax rate on the bonus is 10 percent—that is, the rate on the last dollar you received.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.