Question

Answer the following questions briefly
(a) If a person can choose an income deduction of 500 or a tax credit of 100, who would prefer income deduction?

Answer 1

Answer: the person having higher tax rate burden should prefer income deduction.

Suppose the tax rate is 10% flat and income is $5,000.

If there is income deduction:

Taxable income = Income – Deduction

                           = 5,000 – 500

                           = $4,500

Amount of tax = Taxable income × Rate

                        = 4,500 × 10%

                        = $450

If there is tax credit:

Taxable income = $5,000

Amount of tax = Taxable income × Rate – Tax credit

                        = 5,000 × 10% - 100

                        = 500 – 100

                        = $400

Therefore, if the tax rate is low (as 10%) the amount of tax in case of income deduction is higher than the tax under tax credit; therefore, this is not beneficial and not to be chosen.

Suppose the tax rate is 30% flat and income is $5,000.

If there is income deduction:

Taxable income = Income – Deduction

                           = 5,000 – 500

                           = $4,500

Amount of tax = Taxable income × Rate

                        = 4,500 × 30%

                        = $1,350

If there is tax credit:

Taxable income = $5,000

Amount of tax = Taxable income × Rate – Tax credit

                        = 5,000 × 30% - 100

                        = 1,500 – 100

                        = $1,400

Since the tax rate is high (as 30%), the amount of tax under income deduction becomes low; therefore, this is a cost saving and should be chosen.