TAX DEDUCTIONS AND TAX CREDITS: WHAT'S THE DIFFERENCE?

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

A tax deduction is an amount that reduces your taxable income and, therefore, reduces your tax by your tax bracket percentage. If you have a tax deduction (such as a deductible Traditional IRA contribution, student loan interest, Health Savings Account contribution) in the amount of $2,000, you would reduce your taxable income by $2,000 and would save $200 if you are in the 10% tax bracket, $350 if you are in the 15% tax bracket, $500 if you are in the 25%, etc.

A tax credit, on the other hand, would tax your tax liability and reduce it dollar for dollar. The Child Tax Credit for example is a maximum credit of $1,000 (based on your Adjusted Gross Income). If your tax liability before the credit was $3,000, you would now owe only $2,000.

A tax credit is always better than a tax deduction, if a tax credit is available.