Take deductions
A deduction is an amount you subtract from your income when you file so you don’t pay tax on it. By lowering your income, deductions lower your tax, but do not result in a refund as it cannot reduce your tax below $0.
Claim credits
A credit is an amount you subtract from the tax you owe. This can lower your tax payment or increase your refund. Some credits are refundable — they can give you money back even if you don’t owe any tax.
Tax Deduction
A tax deduction reduces income subject to tax.
For each dollar of tax deduction, the reduction in tax liability is less than a dollar.
Assume that the tax rate is 15 percent and the tax deduction is $200.
| The Effect of Deductions on Income Subject to Tax | ||
| Without Deduction | With Deduction | |
| Income Subject to Tax | $10,000 | $9,800 |
| Tax at 15% | $1,500 | $1,470 |
At a 15 percent tax rate, a $200 tax deduction results in a $30 reduction in the tax.
Tax Credit
A tax credit is a dollar-for-dollar reduction in the tax liability.
For each dollar of tax credit, there is a dollar reduction in the tax liability.
Continuing with the example, assume that the tax credit is $200.
| The Effect of Deductions and Credits on Income Subject to Tax | ||
| Without Deduction With Credit | With Deduction Without Credit | |
| Tax | $1,500 | $1,470 |
| Tax Credit | -200 | 0 |
| Total Tax | $1,300 | $1,470 |
A $200 tax credit results in a $200 reduction in the tax liability. 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.
The taxpayer pays less tax with a $200 tax credit than with a $200 tax deduction.
Donovan Niles 