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December 18, 2023 | read

What’s the Difference Between a Tax Credit and a Tax Deduction?

Giana Caliendo

Tax credits and tax deductions are not the same. They both help in reducing your tax liabilities, but in different ways. Tax credits provide a dollar-for-dollar reduction of your income tax liability. For example, if you have a tax credit of 10,000, then you would save 10,000 on your taxes. Tax deductions reduce how much of your income is subject to taxes. For example, if you are in the 20% tax bracket, a $10,000 deduction saves you $2,000 in tax (0.20 x $10,000 = $2,000).

Let’s go into more detail about each of these:

Tax Credits

Tax credits help to reduce your tax liability dollar-for-dollar, but they cannot lower your income tax liability to less than zero.

There is a catch to tax credits – some are non-refundable. That means any excess amount of tax credits expires in the year in which it was used, meaning that the additional amount is not refunded to you. For example, if your tax bill is $700 dollars and you have a $1,000 non-refundable credit you do not get a $300 dollar refund. The 300 dollar tax credit left over expires that year and cannot be used again.

However, there are also refundable credits, which means the value of the credit goes beyond your tax liability and results in a refund. A few refundable tax credits are earned income tax credit and child tax credit.

Tax Deductions

Tax deductions reduce your taxable income. There are two types of tax deductions: standard deduction & itemized deductions. A taxpayer must use one or the other, but not both. It is generally recommended that you itemize deductions if their total is greater than the standard deduction.

Standard Deduction

The standard deduction is a dollar amount that reduces your tax liability. You can claim the standard deduction on whichever form you file: Form 1040, 1040A or 1040EZ. The amount varies depending on your filing status and is subtracted by your AGI. Below is the 2018 standard deduction amount based on your filing status.

Standard Deduction Categories 2018 2017
Single 12,000 6,350
Married Filing Jointly; and surviving spouse 24,000 12,700
Married Filing Separately 12,000 6,350
Head of Household 18,000 9,300

Itemized Deductions

Itemized deductions are typically used when the amount of qualified deductible expenses are more than the standard deductions. If itemized deductions are more than the standard deduction then your taxable income decrease more.

Itemizing allows your to take advantage of deductions such as home mortgage interest, real estate taxes, medical expenses and charitable donations to name a few! If you decide to itemize make sure you have supporting documents and records.

The catch for itemized deductions is that some are based on a minimum amount, which means you can only deduct amounts that exceed the minimum. There is also an income limitation for taxpayers who itemize deductions if your AGI (adjusted gross income) exceeds a certain level.

Bottom Line

Tax credits and tax deductions are both great ways to lower your tax liability. The main difference is that tax deductions are subtracted from your gross income, while tax credits are subtracted directly from the amount you owe. As a taxpayer, you want to take full advantage of both if you are eligible to claim the deductions and credits to help you pay less income tax.

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