Tax 101: Deduction vs Credit

When it comes to understanding taxes, two terms that are used interchangeably are tax credits and tax deductions. Although they work in a similar way, they both have completely different meanings. Both can help you reduce your tax liability in unique ways, and are easily confused by some people.

Tax Deductions

Are the dollar amounts offered by the IRS used to reduce your adjusted gross income which also lowers your taxable income (the income you would pay taxes on). This is a big help! There are two types of deductions: the standard deduction or itemized deductions.

Tax Credits

Tax credit on the other hand is an incentive that helps taxpayers, like you and me, pay less in taxes because it reduces our tax bill dollar per dollar. Confused? Let me explain. Let’s say for example you have a tax bill of $3,000 and you qualify for a tax credit of $1,500. Your tax bill will be slashed by the amount of your credit. There are several types of credits for qualifying taxpayers, with many available for childcare, low income, and even for college expenses.

What’s unique about tax credits is that they are: refundable or non-refundable.

Refundable means that if the tax credit reduces your tax burden beyond zero you can receive a refund. How cool?

Non-refundable means that if the tax credit reduces your tax burden beyond zero you do not receive any refund. What a blow!

Learning about tax deductions and tax credits both are helpful, especially when it comes to filing taxes and saving money on your bill. Tax deduction or tax credits could be the reason why you pay less or no taxes, or you don’t pay at all. With the ever-changing tax laws, it is even more important that you at least have a basic understanding of tax terms as your taxes is an important factor in your personal finances.

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This material has been prepared for informational purposes, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal, and accounting advisers before engaging in any transaction.