If you are an American taxpayer, then you can reduce your tax load through many methods. The two most popular, however, are probably tax credits and tax deductions. These are not exactly the same thing, though, but two very different methods. You can reduce the amount of tax you owe via a tax credit, whereas a tax deduction helps you decrease your taxable income for the year. Both, however, can put some money in your pocket.
Tax Credits vs. Tax Deductions
When deciding between the value of a tax credit and a tax deduction, you need to comprehend that the two are different. And credits and deductions have limits based on your earnings, so what you can claim gets complicated. A tax expert can assist with sorting out the complication and making sure you know if you can claim a deduction credit, or both, if qualified.
What Does a Tax Credit Mean?
Your tax payment is reduced dollar for dollar when you get a tax credit. For example, your tax payment is cut to $7,000 from $10,000 if you have $10,000 due and are entitled to a $3,000 tax credit. There are already existing tax credits for adoption, installing solar panels, the purchase of an electric car, education costs, etc.
“A tax credit is an amount taxpayers claim on their tax return, generally to reduce their income tax,” stated the Internal Revenue Service
Types of Tax Credits
Tax credits are mainly of three types –
- Refundable.
- Nonrefundable.
- Partially refundable
Refundable Tax Credits
Your tax bill is lowered dollar for dollar by a refundable tax credit, and you receive a refund for the remaining amount if your tax bill is zero. Some common refundable tax credits for you are –
- Child Tax Credit
- EITC or Earned Income Tax Credit
Nonrefundable Tax Credits
In nonrefundable tax credits, you don’t receive the extra tax credit amount as a tax refund when your tax bill is less than the tax credit you are eligible for. For instance, if your tax bill is $2,000 and you qualify for a credit of $2,600, the credit eliminates your tax liability to $0, but you will not receive the additional $600 as a refund.
The common nonrefundable tax credits are –
- Adoption Tax Credit
- Elderly and Disabled Tax Credit
- Lifetime Learning Credit
Partially Refundable Tax Credits
You can be entitled to a refund on a portion of the additional credit after paying part of the credit back in reducing your tax burden to $0. Some of the partially refundable tax credits are –
- Premium Tax Credit
- Additional Child Tax Credit
- American Opportunity Tax Credit.
What is a Tax Deduction?
A tax deduction reduces the amount of your income that you have to pay taxes on. For example, let’s say you were a single filer and claimed the standard deduction, which would reduce your taxable income by $14,600 when you filed for your 2024 return.
If your itemized deductions amount to $15,000, you can subtract that from your taxable income, and less of your income gets taxed. To calculate how much a deduction saves you on taxes, simply multiply the size of the deduction by your tax bracket. A $15,000 tax deduction is worth $3,000 to someone in the 20% tax bracket but $4,500 to someone in the 30% tax bracket.
“Tax deductions are a lot more valuable [for people] in the 37% tax bracket than someone in the 10% tax bracket, because you save 37 cents on the dollar versus 10 cents on the dollar.” – Ted Jenkin, Certified Financial Planner and Co-Founder of oXYGen Financial
Tax Credit Vs. Tax Deduction
A tax deduction lowers how much of your income you must tax. To illustrate, suppose that you were a single filer and took the standard deduction, which would lower your taxable income by $14,600 when you prepared your 2024 return.
If you have itemized deductions of $15,000, you’ll get to deduct that from your taxable income, and less of your income will be subject to taxation. To determine how much a deduction saves you in taxes, merely multiply the size of the deduction by your tax rate. A $15,000 tax deduction is worth $3,000 to someone who pays 20% in taxes but $4,500 to someone who pays 30% in taxes.
“Tax credits are generally more valuable than tax deductions.” – Ted Jenkin, Certified Financial Planner and Co-Founder of oXYGen Financial.
Snapshot: Tax Deductions Vs. Tax Credits
| Feature | Tax Deduction | Tax Credit |
| Calculation | Lowers your taxable income | Lowers your tax bill dollar-for-dollar |
| Eligibility | Relies on your tax filing status, and if itemized deductions surpass your standard deduction | Relies on your filing status, family size, income phase-outs, and IRS laws |
| Impact on taxes | Lowers the income on which your taxes are calculated. | Lowers the tax you owe directly. |
| Examples | Charitable donations, the Standard Deduction, etc. | Foreign Tax Credit, Child Tax Credit, EITC, etc. |
Final Thoughts
Tax credits function as a dollar-for-dollar discount for the tax requirement. It means it directly lowers your tax burden. A tax deduction, on the other hand, lowers your taxable income and is valued according to your tax rate.
Though both are useful for you, a tax credit generally saves more than a deduction of the same value. It is important that you know the eligibility for credits and deductions. You should also understand how to use the most beneficial reporting approach— itemized or standard so that you can obtain the maximum tax benefits.
FAQs
Should I get a $2,000 deduction or a $2,000 credit?
You should receive a $2,000 tax credit, as it will lower your tax bill directly by $2,000.
Can I get a refund from a tax credit?
Yes, you can get a refund on your tax if you are eligible for a refundable tax credit. But your tax credit must be more than your total tax bill.
How is income related to the worth of a tax deduction?
Since the savings depend on your marginal tax bracket, the worth of a deduction rises with increasing income.
Do you require itemizing or get the basic deduction?
To reduce your taxable income as much as possible, you should select the one that gives you the maximum deduction.
What is my marginal tax bracket?
The tax rate on your last dollar of income that determines how large a tax deduction you get is referred to as your marginal tax bracket.