Tax Credits vs. Tax Deductions

Every year, tax time turns up like a bad penny.

Speaking of pennies, if you want to save some of your pennies, it’s important to understand what tax credits and tax deductions are and how they’re different.

Both tax deductions and tax credits can help reduce the amount of taxes you pay, but they work in different ways. Tax credits provide a dollar-for-dollar reduction from your tax bill, and are worth more than deductions but with the same value. Tax deductions reduce your taxable income.

Let’s Dig into Tax Deductions

You’ve probably heard of a tax deduction. But what exactly is it?

A tax deduction is an amount of money subtracted from your income before calculating how much you owe. It reduces the amount of income you pay taxes on, so you could pay less in taxes. How much a deduction saves you depends on your income tax bracket.

When you do your taxes you can choose between taking an itemized deduction or a standard deduction. Of course you should pick the one that saves you money.

Itemized deductions include things like:

  • Student loan interest
  • Medical and dental expenses
  • State and local income tax
  • Property taxes

For example, if you own a home and paid $2,500 in property taxes you may be able to deduct that from your income.

If you don’t have things that can be included in an itemized deduction, or a standard deduction saves you more money, that’s the way to go. The standard deductions for 2019 are $24,400 for people married filing jointly, $18,350 for those filing as head of household, and $12,200 for single and married filing separately.

Tax Credits

While tax deductions come off your income, tax credits shave dollars off your end tax bill.

It’s a dollar-for-dollar reduction in the amount of tax you owe.

Let’s say you owe $5,000 in taxes and you qualify for a $1,000 tax credit of some kind—that tax credit will reduce what you owe in taxes from $5,000 down to $4,000. 

There are federal, state and even some local tax credit programs for all kinds of things, from raising children to restoring historical properties.

Other common tax credits might include:

  • Earned income tax
  • Lifetime learning credit
  • Saver’s tax credit
  • Child tax credit
  • Residential energy-efficient property credit

So, what’s the basic difference in how a tax deduction and a tax credit works?

The big difference between tax credits and tax deductions is this: tax credits directly reduce the amount of taxes you owe right from the beginning. 

Tax deductions chip away at the income you pay taxes on, so you owe less.

The experts can offer a much better, more detailed explanation. 

The Bottom Line

Taxes are confusing—most of us don’t understand them let alone know how to complete them!

How do you do the right things to get the maximum amount back from the government? How do you pay as little as possible? What exactly are tax loopholes, and is that the only way to save money when it comes to taxes? If it makes you feel any better, you’re not the only one asking these questions.

So, there you have it. That wasn’t so bad. Instead of struggling with your taxes this tax season—because let’s face it, most of us don’t have a clue how to file perfectly—why not leave it to the experts to help you get the refund you deserve, and not pay more than your share.