What Is a Tax Credit vs. Tax Deduction?

Money

Tax season is here. As a result, taxpayers should be brushing up on their tax terms so that they can maximize their chances of getting the best results from their tax filing. One excellent example of potential issues is the difference between tax credits and tax deductions, which has been known to confuse a lot of people out there.

What Is a Tax Credit?

In short, a tax credit reduces the amount of taxes that the taxpayer is supposed to pay. As a result, tax credits aren’t included in the calculations until the tax payer has already calculated their tax liability. Generally speaking, interested individuals will separate tax credits into refundable tax credits and non-refundable tax credits. The first kind of tax credit is particularly valuable because they can benefit from them even if they have no tax liability whatsoever. In contrast, the second kind of tax credit can reduce the taxpayer’s tax liability to zero but will have no further effect.

There are numerous tax credits out there, but some of them are much better-known than others. For example, the Earned Income Tax Credit is meant to help out families with either low or moderate income. The maximum amount varies, but the more important part is that what taxpayers will receive is based on various factors such as marital status, number of children, and household income. In contrast, the American Opportunity Tax Credit is meant to help out students in the first few years of their undergraduate education by easing the cost of books, supplies, tuition, and more; while the Lifetime Learning Credit is broader in nature in that it can be used to cover relevant expenses for undergraduate, graduate, and even professional degree courses. Other famous tax credits include but are not limited to Saver’s Credit, Foreign Tax Credit, and Child Tax Credit.

What Is a Tax Deduction?

Unlike tax credits, tax deductions reduce the amount of the taxpayer’s taxable income rather than the amount of taxes that they are supposed to pay. As a result, tax deductions aren’t as good as tax credits on a dollar-for-dollar basis but are nonetheless very useful to have. For those who are curious, tax deductions can be divided into two categories as well, with one being itemized deductions and the other being above the line deductions. The difference between the two is that itemized deductions take away from taxable income while above the line deductions take away from adjusted gross income, which is gross income minus a select set of tax deductions. This is important because adjusted gross income determines whether taxpayers can gain access to various tax credits and tax deductions.

Of course, there are some tax deductions that are very well-known as well. Some examples include but are not limited to medical expenses, mortgage interest, student loan interest, property taxes, and charitable contributions.

What Is the Difference Between Tax Credits and Tax Deductions?

Summed up, tax credits are used to reduce what a taxpayer has to pay in taxes, while tax deductions are used to reduce the amount of a taxpayer’s income that will be taxed at their marginal tax rate. Comparing the two can be interesting, but under normal circumstances, people should be making use of both tax credits and tax deductions to minimize their tax liability as much as possible. Otherwise, they run a high risk of missing out on some good opportunities, which can come with high costs because of that.

Theoretically, interested individuals can look up both tax credits and tax deductions on their own. After all, there is a lot of interest in such matters, meaning that there are a lot of resources out there that exist for the sake of helping out similar people in similar situations. However, if interested individuals want to be sure, they might want to consult a tax preparation professional who specializes in helping out clients in similar circumstances. Yes, such help won’t come free of charge in most cases, but having that kind of expertise and experience can enable interested individuals to get help for not just their tax credits and tax deductions but also other parts of their taxes. Something that can make a huge difference for the final outcome for a lot of taxpayers out there.


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