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Tax deductions vs. Tax Credits: What’s the difference?

There are numerous ways to decrease the tax burden, with tax deductions and tax credits being the most popular ones. Many people confuse the differences in both phrases and frequently use them interchangeably. However, they’re two very distinct mechanisms. Both indeed decrease what needs to be paid in taxes, but tax deduction lowers the taxable income for the year.


Meanwhile, tax credit offers a dollar-for-dollar reduction of the owed tax, helping increase the refunds in some cases. A solid strategy made after consulting experienced tax planning advisors or tax accountants can help you save some cash. Let’s look at some of the key things that help differentiate tax credits from tax deductibles.


Taxation 101

What’s a Tax Credit?

Simply put, tax credits directly decrease the tax amount owed, offering a dollar-for-dollar reduction. Qualifying for a $4000 tax credit would imply that you’ll save $4000 on the tax bill. If not, you’ll get a tax refund. For instance, if you qualify for a refundable tax credit of $1500 and you owe only $1000 in taxes, you’ll receive a tax refund for the $500 credit in excess on the tax bill.


However, not all tax credits are refundable. If the tax credit is non-refundable, it might reduce the tax bill down to $0, but even if the credit was worth more than what you owe, non-refundable credits don’t result in checks from the IRS for the difference. Common refundable tax credits include child tax credits and earned income tax credits. Child and dependent care credit and saver’s credit are some examples of non-refundable credits.


American opportunity tax credit is another tax credit that’s often listed as a partially refundable tax. It’s designed to help families pay for higher education expenses worth up to a limit. If you are or have a dependent who qualifies eligible student, and the tax credit is more than the owed taxes, a significant percentage of the leftover amount could be issued as a refund.


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What’s a Tax Deduction?

Tax deductions help lower the taxable income for the year. You can either claim the standard deduction or itemize the deductions. Standard deductions are the ones taxpayers can claim automatically, depending on their filing status. A married couple filing a joint tax return is considered one of the largest standard deductions. Conversely, itemizing refers to listing individual expenses you’d want to write off on the return. Itemizing typically makes sense when the total deductible expenses are higher than the standard deductions.


Some of the above-the-line and itemized deductions include mortgage loan interest, charitable donations, dental and medical expenses, contributions to health saving accounts or traditional IRAs, property and real estate taxes, educator expenses deduction, job search expenses, and more. Above-the-line deductions can be claimed separately even if you’re not itemizing the deductions. However, the ability to claim some deductions could be limited depending on factors like household income and filing status.


Tax brackets determine the tax rate paid on various chunks of the income. When the marginal tax system increased tax rates as income rises, tax deductions could lead to higher savings for those with higher incomes. Professional tax planning consultants at Nidhi Jain CPA can help you determine whether you should itemize deductions or take the standard deductions by comparing your allowable itemized deductions to the standard deduction amount.

Our tax accountants are CTC-certified and can help you with your tax filing chores while helping you limit your tax liabilities in several ways. We offer various tax preparation and advisory services for personal or business tax filing in Bay Area. People across the US rely on us for comprehensive bay area bookkeeping and accounting services, tax resolution services, payroll services, business formation, and back tax solutions.

You can also call or email us to discover how our cloud-based solutions and cutting-edge AccountantWS software can help you achieve your financial goals while remaining compliant cost-effectively.