Governments use tax incentives as a way to have projects or policies executed by private citizens or businesses. Two primary types of tax incentives are tax credits and tax grants. There are a number of differences between federal tax credits and tax grants. These range from issuing authority to the distribution of funding so it is critical to understand what each is.
Federal Tax Credits
A federal tax credit is an amount a person is allowed to deduct from his reported gross income. For example, if a person made $40,000 and received a $1,000 tax credit, that person's tax liability before taking other deductions would be $39,000. Federal tax credits are available for everything from purchasing green appliances for your home to investing in specific neighborhoods or community programs. Tax credits are incentives aimed at convincing people to spend money on items or programs the government believes are worthy.
State and LocalTax Grants
A grant is a sum of money given to a person or institution for a specific purpose. Grants do not require repayment to the issuing authority. Most tax grants are really a kind of exemption from tax given by taxing authorities. They are forgiveness of taxes already due to the authority. States, counties and municipalities can issue tax grants, usually on property or capital purchases. Many taxing authorities, for example, issue tax grants to nonprofits, allowing them to forgo paying property tax.
Federal Tax Grants
The federal government might issue tax grants to local governments for the same reason it would issue personal tax credits, such as green initiatives. Unlike most tax grants, federal tax grants are funds issued for specific taxes collected. For example, the federal government collects a tax on fertilizer that funds some agricultural tax grants. Taxes on pollutants or harmful chemicals are used by the Environmental Protection Agency to fund clean-up grant programs.
Credits Vs. Grants
The easiest way to remember the difference between a federal tax credit and a tax grant is whether money is exchanged. In the case of grants, funds go out from one account to another. Even when municipalities issue tax grants, they pay one of their accounts from another. With tax credits, no money is exchanged. Instead the money owed a taxing authority is reduced, not moved from one account to another.