Tax credit vs. tax deduction definition
Both tax credits and deductions reduce your tax liability, but they work in different ways.
Tax credits and deductions are similar but different methods of reducing one’s income tax liability. Tax deductions are subtracted from a taxpayer’s adjusted gross income (AGI), which reduces taxable income. Tax credits are subtracted directly from the total amount of taxes someone owes.
Tax credits are generally granted for specific situations and are for a specified amount. For example, the Child Tax Credit allows eligible taxpayers to claim up to $2,000 per qualifying child under age 17, directly reducing the amount of federal income tax they owe.
There are two different kinds of tax credits:
- Non-refundable, which means they can’t take the total amount of taxes someone owes below $0.
- Refundable, which means it’s possible that a tax credit could result in a tax refund.
Tax deductions are split into two kinds: standard and itemized.
- The standard deduction is a set amount determined by your filing status.
- Itemized deductions are specific expenses that someone is allowed to subtract from their taxable income. Instead of taking the standard deduction, a taxpayer opts to itemize when the total of itemized deductions exceeds the standard deduction.
Here’s how to see the difference between a tax credit and a tax deduction:
Tax credit vs. tax deduction: what's the difference?
Tax credit vs. tax deduction
Determining whether a tax credit or tax deduction is better for a federal income tax return depends on the situation. Not everyone may qualify for a tax credit. Remember, they are only granted in certain situations for specific amounts.
As shown above, generally, a tax credit of the same amount is considered “more valuable” than a tax deduction, because a tax deduction only lowers the amount of income someone is liable to pay taxes on. A tax credit reduces the total tax owed.
