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

by ena.rippin , in category: Taxation and Accounting , 9 months ago

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

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1 answer

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by mazie , 9 months ago

@ena.rippin 

A tax deduction and a tax credit are both ways to reduce your taxable income, but they work in different ways:

  1. Tax Deduction: A tax deduction reduces the amount of your income that is subject to taxation. Essentially, it lowers your taxable income, which in turn reduces the total amount of tax you owe. Deductions are typically based on eligible expenses you've incurred during the tax year, such as certain business expenses, mortgage interest, student loan interest, or medical expenses. The deduction reduces your taxable income by subtracting the eligible expenses from your total income, thus lowering the amount of income that is subject to tax.
  2. Tax Credit: A tax credit, on the other hand, is a direct reduction of the tax you owe. It is a dollar-for-dollar reduction in your tax liability. Unlike a deduction that reduces your taxable income, a tax credit is a direct reduction of the tax owed, shrinking the total amount you would pay. Tax credits can be based on various factors, such as having children (Child Tax Credit), adopting a child (Adoption Tax Credit), or making certain energy-efficient home improvements (Residential Energy Credits). Each tax credit has its own eligibility criteria and limitations.


In summary, a tax deduction reduces your taxable income, while a tax credit directly reduces the amount of tax you owe. Tax credits are generally more valuable than deductions as they directly reduce your tax liability, while deductions only lower your taxable income.