Are tax breaks only for the rich? How deductions can work for you, too – USA TODAY

Knowing how tax deductions work will help you answer that question.

Maurie Backman| The Motley Fool

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The U.S. tax code is constantly evolving. And tax code changes are often a big topic of debate, especially when it comes to benefits that are said to primarily benefit the wealthy.

In fact, the tax code is loaded with potential deductions that some critics say only help the rich. But is that really true?

It's easy to see why some people think tax deductions are more beneficial to the wealthy. A tax deduction exempts a portion of your income from taxes. Simply put, if you claim a $1,000 deduction, the IRS won't tax you on $1,000 of earnings. But the amount of savings that amounts to will depend on how much you earn.

Taxes operate under a marginal system that has your highest dollars of earnings taxed at a higher rate than your lowest dollars of earnings. As such, someone who's a higher earner is apt to land in a higher tax bracket than a lower earner. And a tax deduction might then be worth more to that higher earner.

Let's go back to our example of a $1,000 tax deduction. If you're not such a high earner and therefore fall into the 12% tax bracket, a $1,000 tax deduction will result in $120 of savings for you. If you're a very high earner and fall into the 37% tax bracket (the highest one there is), that $1,000 deduction will result in $370 of tax savings. So in this case, the higher earner gets roughly three times the tax break.

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But while tax deductions might favor the rich to some degree, that doesn't mean the tax code is blatantly skewed that way. In fact, there are a number of tax breaks that higher earners can't benefit from.

Last year, the Child Tax Credit got a huge boost as part of the massive stimulus bill that was signed in early 2021. But to qualify for the credit in full, you needed an income of $75,000 or less as a single tax-filer or $150,000 or less as a married couple filing jointly. Once your earnings exceeded that threshold, your credit phased out.

Similarly, there's a credit called the Lifetime Learning Credit that filers can claim against education costs. But you can't claim the credit if your income is $69,000 or more as a single tax-filer, or $138,000 or more as a joint filer.

Therefore, while tax deductions might offer more financial benefits to higher earners, those same earners often lose out on valuable tax credits that could reduce their IRS liability even more. A tax credit is a dollar-for-dollar reduction of your tax liability. And so if you're eligible for a $1,000 tax credit, you automatically pay the IRS $1,000 less, regardless of what tax bracket you fall into. That's a big perk to lose out on.

All told, it's easy to see why the tax code seems to favor the wealthy. But the wealthy do lose out on certain benefits, and it's only fair to acknowledge that. And while some higher earners ultimately see higher tax refunds hit their bank accounts than lower earners, that's definitely not the case universally.

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Are tax breaks only for the rich? How deductions can work for you, too - USA TODAY