Understanding Tax Credits vs. Tax Deductions

Tax credits and tax deductions are both valuable tools for reducing your tax liability, but they work in different ways. Understanding the difference between the two can help you make the most of your tax return.

Tax Deductions:

• What Are They? Deductions reduce the amount of your income that is subject to tax. They lower your taxable income, which can decrease the amount of taxes you owe.
• Examples: Common deductions include mortgage interest, charitable donations, and medical expenses.

Tax Credits:

• What Are They? Tax credits directly reduce the amount of tax you owe, dollar for dollar. Unlike deductions, which lower your taxable income, credits reduce your actual tax bill.
• Examples: Popular tax credits include the Child Tax Credit, Earned Income Tax Credit (EITC), and education credits like the American Opportunity Credit.

Key Differences:

• Impact on Tax Bill: While deductions reduce the amount of income taxed, credits reduce the tax bill itself, often resulting in more substantial savings.
• Refundable vs. Non-Refundable Credits: Some credits are refundable, meaning you can receive a refund even if your tax bill is reduced to zero. Non-refundable credits can reduce your tax liability but won’t result in a refund if they exceed the tax you owe.

Tax credits and deductions both play a crucial role in reducing your tax liability, but they work in different ways. Understanding these differences enables you to strategically plan your tax return and maximize your savings. Let Peggy's Family Tax Service help you identify the best options for your situation to ensure you're getting the most out of your tax benefits.