Tax Credit vs Tax Deduction
Tax credits and tax deductions both reduce your tax liability, but they do it in very different ways. Credits directly reduce the amount of tax you owe, while deductions reduce the income the IRS taxes. Credits are typically more valuable than deductions.
💡Simple Definitions
Tax Deduction:
Lowers the income you are taxed on.
Tax Credit:
Lowers the actual tax you owe — dollar for dollar.
💰 If you want maximum savings: credits are typically more powerful.
📉How Tax Deductions Work
A deduction reduces your taxable income. For example:
$1,000 deduction → reduces taxable income by $1,000
If you're in the 22% tax bracket, that saves you:
$220 in tax
Common deductions include: Standard deduction, itemized deductions (mortgage interest, charitable donations), student loan interest deduction, and business expense deductions.
💎How Tax Credits Work
A tax credit directly reduces your tax bill — dollar for dollar.
$1,000 credit → reduces your tax by $1,000
No matter what tax bracket you're in, a credit saves you its full amount.
Popular tax credits:
- ✓Earned Income Tax Credit (EITC)For low- to moderate-income workers
- ✓Child Tax CreditUp to $2,000 per qualifying child
- ✓Education Credits (AOTC, LLC)For college tuition and expenses
- ✓Premium Tax CreditFor ACA health insurance premiums
Important: Some credits are refundable (meaning you can still get money back even if you owe no tax). Others are nonrefundable.
🔄Refundable vs. Nonrefundable Credits
Refundable Credits
Can reduce your tax below zero and give you a refund.
Example: EITC, Additional Child Tax Credit
Nonrefundable Credits
Can reduce your tax to zero but cannot create a refund.
Example: Lifetime Learning Credit, Child and Dependent Care Credit
Key difference: If you owe $500 in tax and have a $1,000 refundable credit, you get $500 back. With a nonrefundable credit, your tax goes to $0 but you don't get the extra $500.
⚖️Simple Comparison
📉 Deduction:
Lowers income → lowers tax indirectly
💎 Credit:
Lowers tax directly → usually more valuable
💰Example Comparison
You have two options to reduce your tax burden:
Option A: $1,000 Deduction
If you're in the 22% bracket:
Saves $220
Option B: $1,000 Credit
Regardless of your bracket:
Saves $1,000
🏆 Credits win almost every time
A $1,000 credit is worth more than a $1,000 deduction to every taxpayer
🎯When to Use Each
✓ Maximize credits first
Always claim all tax credits you qualify for — they provide the best bang for your buck
✓ Then optimize deductions
Choose between standard deduction (easier) or itemized deductions (if they exceed the standard)
✓ Don't leave money on the table
Many taxpayers miss credits they qualify for — research what's available
🔗Related Terms
Taxable Income →
The income amount subject to tax after deductions
Standard Deduction →
Fixed deduction amount most taxpayers claim
Itemized Deductions →
Specific expenses you can deduct instead of standard deduction
Tax Credit →
Dollar-for-dollar reduction in tax owed
Earned Income Tax Credit →
Refundable credit for low- to moderate-income workers
Tax Bracket →
Income range taxed at a specific rate