Articles · Basics · Individual Income Tax and Form 1040
Tax Credits vs. Tax Deductions
Credits and deductions both lower a tax bill, but they work at different points in the calculation. The difference can be significant.
How each one works
A deduction reduces taxable income, so its value depends on the taxpayer's marginal rate. A credit reduces tax dollar for dollar.
For example, a $1,000 deduction saves $220 for a taxpayer in the 22% bracket. A $1,000 credit saves the full $1,000.
Refundable and nonrefundable credits
A nonrefundable credit can reduce tax to zero but not below it. A refundable credit can produce a refund even when no tax is owed. The earned income tax credit is refundable, and the child tax credit is partly refundable.
Some nonrefundable credits can carry forward to later years, while others are lost if unused. The rules differ by credit.
Common examples
Common deductions include mortgage interest and charitable gifts. Common credits include the child tax credit, education credits, and the foreign tax credit. Many have income limits, so AGI affects eligibility.
Key takeaways
- Deductions reduce income, and credits reduce tax.
- Refundable credits can create a refund.
- Check income limits before relying on either one.
For general education only, not tax advice. Tax law changes often, so confirm current rules and amounts with primary sources.