The taxing system is complicated as it is, so let’s start to simplify it by understanding three crucial terminologies; tax credits, deductions, and adjustments. By understanding financial vernacular, you can empower yourself when making those crucial decisions about how much to spend and how much to save.
Firstly, the three terminologies must be defined so that they can be distinguished. Then you can better understand how to interpret ‘write-offs’ and what to do with your money and your expenses.
Tax adjustments (at times referred to as “above the line deductions”) are expenses that directly reduce your income. Expenses such as university tuition fees, moving expenses, alimony paid, and other expenses of similar purpose.
It is commonly confused that these tax adjustments reduce your tax bill. In fact, they do not. These adjustments directly affect your income, which can in turn reduce your tax bill.
Secondly, tax deductions (sometimes referred to as “below the line deductions”) are most frequently the least rewardable tax deduction of them all. Tax deduction is a term that is applied to itemized deductions, meaning when you purchase an item and pay VAT, you have the right to claim from the tax authorities the VAT paid on the purchased item.
The total sum of itemized deductions, including contributions to charity, interest expense, local taxes, and medical expenses, are subtracted from your adjusted gross disposable income.
This brings you to your taxable income, where you will clarify what VAT was paid and for what item. One common misconception is that, like adjustments, deductions do not directly affect your tax bill.
Finally, tax credits, or refundable tax, is the greatest tax benefit available. Fortunately or unfortunately (depending on where you reside), EU visitors (people who live in a country outside of the EU) are the only people who are eligible for refundable tax. This means that anyone visiting a country in Europe can make purchases of times free of VAT.
Knowing these differences, you can be more aware of your financial actions, whether spending of saving. More importantly, by understanding these terminologies and differences, you can manage your taxes more efficiently.