Differences Between a Tax Credit and a Tax Deduction

If you are someone who pays taxes or is about to start doing it, understanding and knowing the difference between tax credits and tax deductions can save you money. While these two terms may sound similar, they have a different impact on how much taxes you owe. Tax deductions reduce your taxable income, while tax credits reduce the actual taxes that you owe. 

The key difference to keep in mind is that deductions shrink the income you are taxed on, while credits directly lower your tax bill. In New York, individuals and businesses have access to various credits and deductions to ease their tax burden. Common deductions may include mortgage interest, property taxes, and donations to charity.

On the other hand, common tax credits may include EITC or Child Care Credit. Tax laws in New York are tricky, and not understanding them fully can strip you of your advantages. This is why it is recommended to rather hire a CPA in Bedford, NY, to do your taxes than do it yourself. 

What is a tax credit?

A tax credit helps taxpayers to reduce their tax liability. This system works on a dollar-for-dollar basis. Tax credits are better than deductions because they directly reduce the amount of tax you owe. There are different types of tax credits.

For example, refundable tax credits help you get a refund if your tax credit exceeds the amount of tax you owe. Non-refundable tax credits can only help reduce your tax liability to zero. If your tax credit exceeds, you will not get any refund. The child tax credit also falls in this category. 

Partially refundable tax credits are a combination of refundable and non-refundable tax credits. It will help you get a refund for a portion of the credit and also reduce your tax liabilities to zero.

What is a tax deduction?

A tax deduction is an expense that reduces the amount of your income that you pay taxes on.  By lowering the amount of income subject to taxation, deductions can decrease your overall tax burden. When you claim deductions, you subtract those amounts from your total income. 

This reduces the amount of income you pay taxes on. For example, If your income is $50,000 and you have a $5,000 deduction, you will only pay taxes on $45,000.

Key differences between tax credits and tax deductions

The main difference between tax credits and tax deductions is how they affect the overall tax liability. The tax credit allows you to reduce your tax liability directly on a dollar-for-dollar basis. 

For example, if you have a tax credit of $1,000, it means you will have to pay $1,000 less in taxes. However, tax deductions work differently. They reduce the taxable income rather than taxes owed. 

Tax credits are better than tax deductions because they directly reduce the amount of tax you owe, no matter what your income is. However, tax deduction depends on your income. Therefore, how much you save depends on your tax bracket.

The eligibility criteria for tax credits are quite strict as compared to deductions. Many tax credits, such as the Earned Income Tax Credit, have specific income limits and require taxpayers to meet certain conditions to qualify. On the other hand, while tax deductions may require proof of expenses, they do not have strict income limits, like tax credits.

While both tax credits and tax deductions may help you reduce your tax burden, they do so in different ways. Tax credits offer you direct savings; tax deductions may help you lower your taxable income.

Learn to save money through taxes!

Nobody likes to pay taxes. After all, it takes a lot from your hard-earned income! Taking full advantage of available credits and deductions can save you money. Hire a CPA today!