Tax Credit Vs Deduction

What is the difference between a tax credit and a deduction?

A tax credit reduces your tax bill dollar for dollar, while a deduction reduces your taxable income. A $1,000 credit saves you $1,000 in taxes. A $1,000 deduction saves you $1,000 times your tax rate, so perhaps $220 to $370 depending on your bracket. Credits are more valuable because they directly reduce what you owe.

Types of credits

Nonrefundable credits can only reduce your tax to zero. Refundable credits can result in a refund even if you owe no tax. Partially refundable credits fall between. Examples of business credits include the research and development credit, work opportunity credit, and small employer health insurance credit. Each has specific eligibility rules and calculation methods.

Maximizing both

Take all deductions you are entitled to, as they reduce taxable income and thus tax liability. Then apply available credits to further reduce or eliminate remaining tax. Work with your accountant to identify credits you may qualify for, as many go unclaimed. The interaction between credits, deductions, and income thresholds can be complex.