Tax Credits vs Tax Deductions

Do you know the difference between tax credits vs tax deductions?

Tax Credits generally reduce your income tax on a dollar-for-dollar basis on the amount of tax owed.  As an example, if you have a $10 tax liability and $10 dollar tax credit, the tax credit will offset the tax due.  

Tax credits come in various forms including nonrefundable tax credits, refundable tax credits and business tax credits.  A nonrefundable tax credit can reduce the tax owed to zero but cannot result in a refund if the credit exceeds the tax liability.  A refundable credit not only reduces the tax liability to zero but also allows the taxpayer to receive a refund if the credit exceeds the tax owed.  Business credits are available for various activities including research and development and hiring certain groups of workers.

Tax deductions reduce a taxpayer’s income before the amount of tax due is calculated.  For example, for simplicity purposes, consider the following facts:

A taxpayer has income of $100, deductions of $10 and a 10% tax rate. At the end of the day, the taxpayer still has a $9 tax liability. The $9 is computed by taking the $100 in income, subtracting the $10 deduction leaving $90 in taxable income. The $90 of taxable income is then multiplied by the 10% tax rate leaving a $9 tax liability. Compare this with the use of the $10 tax credit described above.

Please consult your tax preparer or use the IRS website at irs.gov to understand eligibility requirements for tax credits or tax deductions.  Explore all available tax credits and tax deductions and leverage those that align with your circumstances and financial goals. 

Disclaimer:  The information presented above should not be relied upon as tax advice.