Tax Deductions vs Tax Credits: Understanding the Difference
When preparing for the next tax season, two terms that often cause confusion among taxpayers are tax deductions and tax credits. While both can help reduce your tax burden, they work in fundamentally different ways.
At Tax Pros Online, we understand that navigating the complex world of tax benefits can be challenging. Let’s break down these important concepts to help you better understand how they can benefit your financial situation.
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Tax Deductions: Reducing Your Taxable Income
Tax deductions work by lowering your taxable income before your tax rate is applied. Think of deductions as subtracting eligible expenses from your gross income to determine how much of your income is actually subject to taxation. The value of a deduction depends on your tax bracket – the higher your tax bracket, the more valuable the deduction becomes.
For example, if you’re in the 22% tax bracket, a $1,000 tax deduction would reduce your taxable income by $1,000, resulting in tax savings of $220 (22% of $1,000). Common tax deductions include:
- Mortgage interest payments
- State and local tax payments (SALT), up to $10,000
- Charitable contributions
- Student loan interest
- Business expenses for self-employed individuals
- Medical expenses exceeding 7.5% of adjusted gross income
Have questions on standard deductions vs itemized deductions? Read more in our article linked here.
Tax Credits: Dollar-for-Dollar Tax Reduction
Tax credits are even more valuable than deductions because they directly reduce your tax bill dollar for dollar, regardless of your tax bracket. A $1,000 tax credit reduces your tax bill by exactly $1,000, making credits particularly powerful for lowering your tax liability.
Tax credits come in two forms:
Refundable Credits
These can result in a tax refund if the credit amount exceeds your tax liability. Examples include:
- Earned Income Tax Credit (EITC)
- Additional Child Tax Credit
- American Opportunity Tax Credit (partially refundable)
Non-Refundable Credits
These can reduce your tax liability to zero but won’t result in a refund. Common examples include:
- Child and Dependent Care Credit
- Adoption Credit
- Lifetime Learning Credit
- Solar Energy Credit
Contact Tax Pros Online!
Have questions about maximizing your tax deductions and credits? The experienced team at Tax Pros Online is here to help! Our tax professionals can analyze your unique situation and identify all available tax benefits to minimize your tax liability and maximize your refund.
When you choose to work with our tax professionals, we’ll discuss tax credits, how to fill out a W-4, tax filing status options, when your taxes are due, and more. Here is a list of services that we offer.
Contact us today to schedule a free consultation to discover how we can help you make the most of your tax deductions and credits this tax season. Start now for free!
Related: What Student Tax Credits Can I Claim for My Education Expenses?