Person using calculator to compare difference between tax deduction and tax credit

The difference between tax credits and tax deductions is something that can often be misunderstood. Their purposes have a similar end result, and both can play a significant role when you file taxes (namely, to save you money as a taxpayer), which makes knowing their differences crucial. Here are the fundamental differences between tax credits vs tax deductions.

What is the Difference Between a Tax Credit vs. Tax Deduction? 

There are four key differences between a tax credit vs. tax deduction: 

How they reduce the amount of tax owed

Both tax credits and tax deductions reduce the amount owed but in different ways. Tax credits reduce the amount of tax owed by lowering your tax liability or the amount owed. Tax deductions will reduce the amount of income that’s taxable.

How many of each you can claim

The second difference between a tax credit and a tax deduction is how many of each you can claim. You can claim multiple tax credits as long as you’re eligible for them. Tax deductions are available in two formats: itemized deductions and standard deductions. You can only choose one of these formats. 

Their types

The third difference between a tax credit and a tax deduction is their types. Tax credits are either ‌non-refundable or refundable. Tax deductions are available either as itemized deductions or the standard deduction.

Possibility of a refund

The final difference between a tax credit and a tax deduction is the possibility of a refund. Tax deductions lower your taxable income and can lead to a refund if they reduce your liability enough that you've overpaid through withholding or estimated tax payments. Tax credits, on the other hand, directly decrease your tax liability. Some are "refundable," meaning they can result in a refund if the credit exceeds your total tax liability, regardless of your tax payments throughout the year.

Is a Tax Deduction or Tax Credit Better? 

There are several factors that may make both tax credits and tax deductions considerable. Tax credits and tax deductions are both helpful, but there’s one that is better for taxpayers. 

For tax deductions, you have the option of taking an itemized deduction or a standard deduction. However, you can’t take both deductions in the same tax year. 

Itemizing deductions allows you to claim specific deductions, but you’ll need to complete a separate tax form. The standard deduction is another choice that may work for you. While you don’t need to complete another tax form, the amount you’ll receive for a standard deduction varies based on your filing status.

Tax credits are the more favorable option because they directly reduce the amount of taxes you owe. Tax deductions reduce your taxable income but this is largely affected by marginal tax brackets.

Here are a few additional reasons why tax credits are more beneficial:  

  • You may qualify for tax gross credits regardless of your income or tax liability. 
  • Tax credits are available as non-refundable and refundable. Non-refundable tax credits can decrease taxes owed to the Internal Revenue Service (IRS), bringing your tax liability down to zero. However, the IRS will keep the balance after having zero tax liability.
  • Refundable tax credits can reduce your tax liability to zero or even below zero. When your tax liability is below zero, you’ll receive a refund.

    • Examples of Tax Credits 

    Individuals and small businesses alike can qualify for tax credits. Common tax credits include: 

  • Child and Dependent Care Credit: Allows taxpayers to receive reimbursements for their expenses for the care of qualifying dependents. For tax year 2022, the maximum amount of care expenses you're allowed to claim is $3,000 for one person or $6,000 for two or more people. The percentage of your qualified expenses that you can claim ranges from 20% to 35%.
  • Child Tax Credit: The CTC is offered for child dependents under age 17 before December 31 who live with taxpayers for at least half of the year. The Child Tax Credit is up to $3,000 for children aged six to 17, and up to $3,600 for children younger than six years old.
  • Earned Income Tax Credit: A refundable tax credit available to low-income and moderate-income workers. 
  • Premium Tax Credit: A refundable tax credit available for families and individuals that covers health insurance premiums offered through the Health Insurance Marketplace. This credit comes with income requirements and must be filed with Form 8962. 
  • Qualified Plug-in Electric Drive Vehicle Tax Credit: This tax credit ranges from $2,500 to $7,500 for new vehicles that are all-electric or plug-in models.
  • Saver’s Credit: The Saver’s Credit is available for taxpayers who make eligible contributions to their employer-sponsored retirement plan or with an IRA. This credit amount will vary according to the adjusted gross income on your Form 1040.
  • Work Opportunity Tax Credit: The Work Opportunity Tax Credit is a business credit available for employers that expires in 2025. This credit is for employers who hire employees in 10 targeted groups, and the maximum amount for this credit is 40% of up to $6,000, or up to $2,400.

    • Examples of Tax Deductions

    Whether you’re an individual or part of a small business, you also qualify for tax deductions. There are two ways of receiving a tax deduction. You can choose a standard deduction, which is a fixed amount, to reduce your taxable income. Or, you can itemize deductions on your tax return. Some ‌deductions you can itemize include:

  • Charitable donations
  • Interest expense
  • Medical and dental expenses
  • Miscellaneous deductions
  • Education expenses

    • Small business owners can receive tax deductions for different business expenses, such as:

  • Charitable contributions
  • Equipment
  • License and regulatory fees
  • Taxes 
  • Vehicle expenses

    • Check out this helpful tax deduction checklist for more information.

    Lower Your Tax Bill with 1-800Accountant

    Figuring out which tax deductions and tax credits you apply for is the best way to lower your bill this tax season. However, if you miss deductions or credits you qualify for, you’ll likely leave money on the table and overpay taxes to the IRS. When it’s time for you to file your taxes, work with the business tax professionals at 1-800Accountant to lower your tax bill. 

    We’ll prepare your personal tax return with accuracy guaranteed – no matter how complex your situation is. We review everything with you, then file your taxes on your behalf. Enjoy peace of mind while the experts handle the complicated stuff!

    This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.