Tax credit – What it is, definition and concept

That is, the tax credit is an economic amount in favor of the taxpayer when paying a tax. This allows the subject to pay less taxes or have a favorable balance with the collecting or tax authority.

The amount of this credit balance depends on the deductible expenses incurred by the subject. These can be included in the declaration by the law that regulates the tax in question.

So if we are required to pay, for example, $ 1,000 of a tax and we have a tax credit of $ 80, our payment obligation will be $ 920. This, since the amount of the tax credit is already in the hands of the administration (We will present an example with more details later).

Deductible expenses and tax credit

But, let’s get back to the concept of deductible expense. We must remember that when we acquire a certain good or service we face the payment of the price of the product added to the corresponding tax, incurring, therefore, an expense. This could be the case for a deductible expense.

In that sense, let us remember that a deductible expense is one that can be included in the declaration of a tax that is paid based on the income and expenses of the declarant. This expense allows the value of the amount entered by the subject to be reduced in the face of the Public Administration, that is, it allows reducing the taxable base on which the tax will be calculated.

For this reason, by including deductible expenses, the amount to be paid for taxes will be lower compared to the corresponding amount in the case of only accounting for income.

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The tax credit is a concept used in taxes such as Value Added Tax (VAT) or Personal Income Tax (IRPF).

It should also be noted that, depending on each type of tax, deductible expenses are accounted for as reductions in earned income (IRPF) or as advance payment of a tax (VAT).

Tax credit example

Suppose we are a company in charge of the manufacture of coffee cups. In order to manufacture them we need to buy the ceramics from our supplier. We have a wide network of clients and this last year we have recorded the following deductible income and expenses in the Value Added Tax (VAT):

  • Income: $ 500,000 + $ 105,000 VAT
  • Deductible expenses: $ 100,000 + $ 21,000 VAT

The tax rate for this tax is 21%, therefore, in relation to income, we would have to pay $ 105,000 VAT. However, due to deductible expenses, we have a tax credit worth $ 21,000. In this case, the amount that we will be responsible for paying VAT will be that resulting from the following operation.

Tax amount: 105,000 – 21,000 = $ 84,000

In conclusion, the tax credit is the amount that is subtracted from the amount to be paid for a tax by a subject. This subtracted amount depends on the deductible expenses that have been included in the declaration.

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