What’s the Difference Between A Tax Credit vs A Tax Deduction?

Now that we’re approaching tax season, people are weighing their financial options, and what to claim or deduct. One thorny area that tends to trip people up is the difference between a tax credit or a tax deduction. The good news is that once you dive in, this topic isn’t too tricky, it just requires a bit of critical thinking.

What’s the Difference?

The difference between a tax credit and a tax deduction is fairly simple: deductions lower your amount of taxable income, while a credit lowers your overall payment dollar-for-dollar. But what does this look like in real numbers?

If you have a $100 tax deduction and have $10,000 in taxable income, then this lowers your taxable income amount to $9,900. If you’re in the 25% tax bracket, you’ll pay $2,475 in taxes.

On the other hand, if you made $10,000, are in the 25% tax bracket, and receive a $100 tax credit, you’ll pay $2,400 in taxes.

What Are Some Common Tax Credits?

As the tax code evolves with our society, so do the credits that are available for people. Some common examples of tax credits are the earned income tax credit, the premium tax credit (Affordable Care Act), and the mortgage interest tax credit. However, there are others you may find useful as well, like the child and dependent care credit, which is particularly helpful for those in the sandwich generation since they care for younger and older people and often need assistance in doing so. The residential energy efficient property credit is also helpful if you have an energy efficient home.

What Are Some Common Tax Deductions?

Tax deductions are a bit less straightforward and can require some meticulous record keeping on your end. For example, if you use your own car for business purposes, you can deduct that, but the amount will vary. Or if you’ve donated to charity, that’s also deductible, depending on your income bracket. Are you paying off your student loans? You’ll get a small break for that as well. Health Savings Accounts (HSAs) will also save you a few dollars, as long as you have the documentation. So, save those receipts!

There are also deductions you can make from your retirement account contributions, like your IRA or 401(k) plan. If you have a financial advisor, ask about how you can best maximize your contributions to not only help secure your financial future down the road, but also in the short term with tax breaks.

If you’re still confused about taxes, you’re far from alone. That’s why when in doubt, it’s a good idea to work with a tax professional to help ensure you keep as much of your hard-earned cash as possible.