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What is the difference between a Tax Credit and a Tax Deduction?

What is the difference between a Tax Credit and a Tax Deduction?

One of the most important reasons why it is crucial to get your tax filing correct is so that you will be able to take advantage of all the credits and deductions that are due to you. The sad reality, however, is that many taxpayers do not know the meaning or difference between the two, hence, they end up missing out on hundreds (or at times even thousands) of dollars in unclaimed refunds.

The basic differences between a tax credit and a tax deduction are explained below.

How is a Tax Credit different from a Tax Deduction?

When it comes to differentiating between tax credits and deductions, the major thing you should keep in mind is that tax credits reduce the amount of your tax liability, while a tax reduction reduces the overall amount of your taxable income.

Both a tax credit and a tax deduction will reduce the overall amount that you are required to pay in taxes, however, it is how they do so that is often misunderstood.

A good example is an individual who makes $100,000 in a fiscal year. At a tax rate of 22%, their tax liability (the amount that they have to pay in taxes) will be $13,728. A tax credit will decrease the amount the individual has to pay by reducing the $13,728 tax liability, while a tax deduction will serve the same function by reducing the $100,000.

Another notable difference is how they affect your tax returns. While a tax deduction could lower your tax bracket, a tax credit, on the other hand, is a “dollar-for-dollar” reduction on the amount of your tax liability.

There are several tax credits and deductions that you may qualify for, and a certified tax consultant is better poised to help you take advantage of these opportunities.

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