Tax Credits vs Tax Deductions

Short Answer: Tax deductions lower your taxable income, potentially lowering your tax burden. In contrast, tax credits decrease your tax bill and may even boost your refund.

What Is a Tax Credit?

A tax credit directly lowers the amount of taxes you owe on a dollar-for-dollar basis. For instance, if you are eligible for a $2,000 tax credit, you will save $2,000 on a tax bill.

What You Need to Know About Tax Credits

You can’t get a refund on some tax credits. They can lower your tax bill to zero, but if the credit is worth more than you owe on the bill, the IRS will not send you a check for the rest of the sum. For instance, a $1,700 tax bill and a $2,000 nonrefundable tax credit won’t result in a $300 refund check.

That said, some tax credits, like the child tax credit (ACTC) or earned income tax credit (EITC), are refundable. So, you will get a refund check if you are eligible and the credit value surpasses your tax liability.

Still, remember that the IRS has strict requirements for nonrefundable and refundable credits. It would be best to consult them before applying.

What Is a Tax Deduction?

A tax deduction reduces your taxable income, thus lowering your tax burden. Unlike a tax credit, a deduction does not reduce your tax burden dollar for dollar. Instead, the amount by which it decreases your tax payment is determined by your tax brackets. For instance, if your company falls under the 10% bracket, a $2,000 deduction will save you $200.

Tax Deduction Strategies to Consider

You can go about tax deduction in two ways: taking the standard deduction or itemizing.

The standard deduction is an all-encompassing decrease in the amount of your taxable income. The good thing about this incentive is that the application process is fairly simple. You can claim the deduction on Form 1040. However, keep in mind that the amount will depend on your filing status.

On the other hand, itemizing helps you to deduct expenses such as house mortgage interest, medical and dental bills, and charitable contributions. To apply, you must use Schedule A and Form 1040. However, if you notice that your itemized deductions exceed the standard deduction, you should itemize so that you pay less tax.

In any case, you’ll need to choose between the standard deduction and itemizing. While you can opt for either, you can’t claim both.

Conclusion

Lower your tax burden with the help of tax credits and tax deductions. Learning their ins and outs will assist you in saving more money. But claiming deductions and tax credits involves satisfying specific conditions depending on the amount of your taxable income, current life events, and filing status. Therefore, ensure you meet the IRS tax credits and deductions rules before you apply.

This page was last updated by Steven Jefferies