Tax Credits vs. Tax Deductions: What’s The Difference?

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Tax deductions and tax credits both save you money on your taxes, but they work in different ways.

• Tax credit: A tax credit gives you a dollar-for-dollar reduction on your tax bill. For example, if you owe $10,000 and you’re eligible for a $2,000 tax credit, that credit cuts your tax bill by $2,000 — to $8,000. Currently, tax credits are offered for education costs, installing solar panels, purchasing an electric vehicle, adopting a child, and more.
• Tax deduction: A tax deduction reduces the amount of your income subject to tax. For example, if you’re a single filer and you claim the standard deduction, that will reduce your taxable income by $14,600 on your 2024 tax return. If you decide to itemize, you can deduct items such as medical expenses and charitable contributions. If, say, your itemized deductions add up to $20,000, you can shave that amount off of your taxable income, meaning that less of your income is subject to tax. To calculate how much a deduction saves you on your tax bill, simply multiply the value of the deduction times your tax bracket. A $20,000 tax deduction, for example, is worth $7,000 to someone in the 35 percent tax bracket, while it’s worth $2,400 to someone in the 12 percent bracket.

Types of tax credits

There are three types of tax credits:

• Refundable.
• Nonrefundable.
• Partially refundable.

Refundable tax credits

A refundable tax credit reduces your tax bill dollar-for-dollar, and if your tax bill goes to zero, then you get the rest of that tax credit paid to you as a refund. Some refundable tax credits include:

• Earned income tax credit, or EITC: The maximum amount of this fully refundable credit ranges from $632 to $7,830, depending on the number of qualifying children, for tax year 2024 (for tax returns filed in 2025).
• Child tax credit: The maximum amount of this credit is $2,000 per qualifying child under age 17 at the end of 2024, with up to $1,700 refundable for 2024.

Nonrefundable tax credits

If a tax credit is greater than your actual tax bill but the credit is nonrefundable, you don’t get the difference as a tax refund. For example, if you owe $1,500 in taxes and are eligible for a $2,000 credit, the credit reduces your tax bill to zero, but you don’t get a refund for the remaining $500.

Some nonrefundable tax credits include:

• Adoption tax credit: This tax credit is worth up to $16,810 for 2024 (tax returns filed in 2025), if you have eligible expenses related to adopting a child.
• Elderly and disabled tax credit: This tax credit, for lower-income people aged 65 and older or permanently disabled, is worth $3,750 to $7,500 on 2024 tax returns filed in 2025.
• Lifetime learning credit: This tax credit can offset qualified education costs up to $2,000 on 2024 tax returns filed in 2025.

Partially refundable tax credits

A partially refundable tax credit can be used to reduce your tax bill to zero and from there, you may be eligible to get a refund on a portion of the remaining credit.

For example, the American opportunity tax credit, designed to help families pay for higher education expenses, is worth up to $2,500 per eligible student. If your tax bill is less than the full credit, you can claim 40 percent of the remaining amount as a refundable credit, up to $1,000.

Tax credit vs. tax deduction: An example

Tax credit or tax deduction: Which one is better?

Any deduction or credit that will trim your tax bill is a good thing. That said, the amount a tax deduction saves you will depend on your federal income tax bracket — the higher your tax bracket, the more valuable a tax deduction is. But tax credits give you a dollar-for-dollar reduction on the amount you owe. For this reason, tax credits outshine tax deductions for many taxpayers.

Still, deductions reduce your taxable income by the percentage of your highest tax bracket, and can save you money at tax time. For example, if you are in the 24 percent tax bracket, a $1,000 deduction will save you $240 (1,000 x 0.24 = 240) on your tax bill.

Deductions are worth more the higher your tax bracket. A $10,000 deduction is worth $3,500 to someone in the 35 percent tax bracket, while it’s worth about one third of that — just $1,200 — to someone in the 12 percent tax bracket.

With deductions, you can take either the standard deduction or you can itemize, but you can’t do both. If your itemized expenses, such as medical bills, home mortgage interest and charitable donations, total a higher dollar amount than the standard deduction, you’ll save money by itemizing.

If you do itemize your deductions, take the time to make sure you’re not forgetting anything. Property taxes are a big one and can have a sizable impact on reducing your tax bill, but this particular expense may be overlooked because there’s no dedicated tax form that a county or the government is required to send you.