Tax deductions vs. tax credits: How to tell the difference

Tax credits and deductions both reduce your tax bill, but in different ways. Tax credits directly reduce the amount of tax you owe, while tax deductions reduce how much of your income is subject to taxes.

Shannon Stapleton/Reuters/File
U.S. 1040 Individual Income Tax forms.

Tax credits and tax deductions may be the most satisfying part of preparing your tax return.

Both reduce your tax bill, but in very different ways.

Tax credits directly reduce the amount of tax you owe, giving you a dollar-for-dollar reduction of your tax liability. A tax credit valued at $1,000, for instance, lowers your tax bill by the corresponding $1,000.

Tax deductions, on the other hand, reduce how much of your income is subject to taxes. Deductions lower your taxable income by the percentage of your highest federal tax bracket. So if you fall into the 25% tax bracket, a $1,000 deduction saves you $250.

The catch to tax credits

Some tax credits are intended to help cover individual costs around buying a first home, adopting a child, child care expenses, home office expenses or caring for an elderly parent.

But these are nonrefundable tax credits.  If you don’t owe a lot in taxes to begin with, you don’t get the full value if the credits take your tax bill below zero.  In other words, a $600 tax bill combined with a $1,000 credit doesn’t get you a $400 tax refund check.

Other credits are refundable. If you qualify to take refundable tax credits — things like the Earned Income Tax Credit, the Health Coverage Tax Credit, the Making Work Pay Credit, the Child Tax Credit and the Additional Child Tax Credit — the value of the credit goes beyond your tax liability and can result in a refund check.

The IRS lays out specific criteria you must meet to qualify for both nonrefundable and refundable credits.

As you run the tax credit calculations in your return, keep in mind that you must establish the amount of your gross income tax liability before you apply any credits. The credits don’t reduce your taxable income.

But tax deductions do.

The catch to tax deductions

There are two types of tax deductions.

The standard deduction is a one-size-fits-all reduction in the amount of your income that’s subject to tax. You don’t have to do anything to qualify for the standard deduction or provide any documentation.

You can claim the standard deduction on whichever form you file:Form 1040, 1040A or 1040EZ. The standard deduction in 2015 for single filers and married couples filing separately is $6,300; it’s $12,600 for married couples filing jointly. For those filing as heads of household, the standard deduction is $9,250.

But you may be better off opting to use the second type of deduction, the itemized deduction, instead.

Itemizing allows you to total the amount you spent on allowable deductions such as home mortgage interest, medical expenses or charitable donations. If together they exceed the value of the standard deduction, you’ll want to itemize.  You’ll need to use the regular 1040 filing form and Schedule A. 

Taking the standard deduction or itemized deductions is an either/or situation.  You can claim one kind or the other, but not both.  

And, just as with tax credits, taking certain deductions requires meeting certain qualifications based on your filing status, current life events and the amount of your income that’s taxable. Be sure you meet IRS criteria to qualify for both tax credits and deductions.

This article first appeared in NerdWallet. 

You've read  of  free articles. Subscribe to continue.
Real news can be honest, hopeful, credible, constructive.
What is the Monitor difference? Tackling the tough headlines – with humanity. Listening to sources – with respect. Seeing the story that others are missing by reporting what so often gets overlooked: the values that connect us. That’s Monitor reporting – news that changes how you see the world.

Dear Reader,

About a year ago, I happened upon this statement about the Monitor in the Harvard Business Review – under the charming heading of “do things that don’t interest you”:

“Many things that end up” being meaningful, writes social scientist Joseph Grenny, “have come from conference workshops, articles, or online videos that began as a chore and ended with an insight. My work in Kenya, for example, was heavily influenced by a Christian Science Monitor article I had forced myself to read 10 years earlier. Sometimes, we call things ‘boring’ simply because they lie outside the box we are currently in.”

If you were to come up with a punchline to a joke about the Monitor, that would probably be it. We’re seen as being global, fair, insightful, and perhaps a bit too earnest. We’re the bran muffin of journalism.

But you know what? We change lives. And I’m going to argue that we change lives precisely because we force open that too-small box that most human beings think they live in.

The Monitor is a peculiar little publication that’s hard for the world to figure out. We’re run by a church, but we’re not only for church members and we’re not about converting people. We’re known as being fair even as the world becomes as polarized as at any time since the newspaper’s founding in 1908.

We have a mission beyond circulation, we want to bridge divides. We’re about kicking down the door of thought everywhere and saying, “You are bigger and more capable than you realize. And we can prove it.”

If you’re looking for bran muffin journalism, you can subscribe to the Monitor for $15. You’ll get the Monitor Weekly magazine, the Monitor Daily email, and unlimited access to

QR Code to Tax deductions vs. tax credits: How to tell the difference
Read this article in
QR Code to Subscription page
Start your subscription today