- Alex Smith
Tax Credits vs Deductions
Not sure about the difference between a tax credit and a deduction?
Tax credits are a direct reduction of the income tax you owe, reducing the amount you need need to pay to the IRS. Tax credits can be refundable or nonrefundable, meaning that a nonrefundable credit can only reduce the amount of tax you owe to $0. Credits that are refundable (and there is only a few) will reduce the amount of tax you owe to $0, and the government will provide you a refund of the unused portion.
Quick Example: Say that you owe the IRS $1,200 in taxes, but you have a tax credit worth $1,500. The tax credit would cover the $1,200 that you owe and there would be $300 unused. Unless the credit was refundable, the IRS would keep that $300.
Common tax credits include:
American Opportunity Credit (AOC)
Earned Income Credit (EIC)
Credit for Elderly and Disabled
Deductions are different, and reduce the amount of income you are taxed on. The two types of deductions are standard and itemized. Standard deductions are based on your age, income, and filing status while itemized deductions are based off of things like your home mortgage, medical expenses, and charitable giving.
Quick Example: You earned $75,000 in gross income this year. If you were filing as a single tax payer, you would take a standard deduction of $12,550, and you would only be taxed on $62,450.