Tax Credits vs Tax Deductions

Tax credits and deductions both can lower tax, but they work differently. A deduction reduces taxable income. A credit reduces tax liability more directly.

How deductions work

If a deduction lowers taxable income by $1,000, the tax savings depends on the marginal tax rate. Someone in a 22% bracket may save about $220 in federal tax from that deduction, before considering other rules.

How credits work

A $1,000 tax credit can reduce tax liability by up to $1,000, depending on whether it is refundable, nonrefundable, or partially refundable. Credits often have eligibility rules and phaseouts.

Why this matters

When comparing tax strategies, do not treat a deduction and a credit of the same dollar amount as equal. The effect can be very different.