Tax Credit vs. Tax Deduction - NerdWallet (2024)

FAQs

Tax Credit vs. Tax Deduction - NerdWallet? ›

A deduction cuts the income you're taxed on, which can mean a lower bill. A credit cuts your tax bill directly.

Generally, tax credits tend to be more valuable compared to deductions. That's because of the dollar-for-dollar reduction mentioned earlier.

Tax credits are generally more valuable than tax deductions. There are many types of each: nonrefundable, partially refundable and fully refundable tax credits, and standard vs. itemized deductions, for example.

Remember, tax deductions reduce your taxable income, and your marginal tax rate determines the amount you save. For example, if you're in the 20% tax bracket, a $1,000 deduction would save you $200 (20% of $1,000). On the other hand, tax credits reduce your tax liability dollar for dollar.

A tax credit reduces the specific amount of the tax that an individual owes. For example, say that you have a $500 tax credit and a $3,500 tax bill. The tax credit would reduce your bill to $3,000. Refundable tax credits do provide you with a refund if they have money left over after reducing your tax bill to zero.

Tax deductions and tax credits are ways to whittle down what you owe to Uncle Sam. Both can lower your tax bill but do so in different ways: While tax deductions reduce the amount of your income subject to tax, tax credits reduce your tax liability directly.

Another beneficial way to boost your refund is through tax deductions. Tax deductions lower your taxable income, which in turn can lower your tax bill.

Tax credits are always more valuable than deductions because they cut your bottom-line tax bill dollar for dollar.

Tax credits for businesses

Tax credits are direct reductions in the tax amount a business owes. For example, if a company qualifies for a $5,000 tax credit, its tax liability decreases by that same amount.

This is a dollar-for-dollar reduction in the tax liability. With a $200 tax deduction, the total tax is $1,470. With a $200 tax credit, the total tax is $1,300.

Is a dependent a deduction or credit? ›

The Child Tax Credit is up to $2,000. The Credit for Other Dependents is worth up to $500. The IRS defines a dependent as a qualifying child (under age 19 or under 24 if a full-time student, or any age if permanently and totally disabled) or a qualifying relative.

A tax credit is a dollar-for-dollar reduction in your income. For example, if your total tax on your return is $1,000 but you are eligible for a $1,000 tax credit, your net liability drops to zero.

Key Takeaways

Identifying and claiming tax deductions will reduce your taxable income. Exploring tax credits can significantly increase tax refunds. Maximizing contributions to retirement accounts can increase tax benefits. Consider adjusting withholding to optimize tax refunds.

You can't claim the EIC unless your investment income is $11,000 or less. If your investment income is more than $11,000, you can't claim the credit. Use Worksheet 1 in this chapter to figure your investment income.

Itemizing tax deductions and claiming lesser-known credits are among the ways to boost your refund. Tax deductible contributions can be made to traditional IRAs and health savings accounts up until tax day. Asking a new accountant to review your return may uncover additional tax-savings options.

In contrast to exemptions and deductions, which reduce a filer's taxable income, credits directly reduce a filer's tax liability — that is, the amount of tax a filer owes. Taxpayers subtract their credits from the tax they would otherwise owe to determine their final tax liability.

According to Experian™, credit reports “don't track tax bills or payments, so your record of paying taxes on time, or failing to do so, does not factor into the calculation of your credit score.” However, not paying your taxes or using a specific payment method—such as a credit card—could indirectly hurt your score.