Taxes 
12
comments

Tax Credit vs. Tax Deduction

Email  Print Print  

A tax credit is not the same as a tax deduction.

Tax Deduction

A tax deduction, such as contributions to a Traditional IRA or 401(k), reduces your adjusted gross income. How much that deduction is worth to you depends on your marginal income tax rate (2008 Federal Tax Brackets).

If you are in the 25% tax bracket, a $1000 tax deduction means you will pay $250 less tax that year. If you are in the 10% bracket, a $1000 tax deduction means you’ll pay $100 less tax that year. If you have a simple tax situation, with little income outside of your regular job, this translates to a larger tax refund.

Common tax deductions are the two mentioned before, Traditional IRA and 401(k) contributions, as well as mortgage loan interest, student loan interest, and charitable donations.

Tax Credits

A tax credit is a dollar for dollar reduction in your income taxes. If you have a $1000 tax credit, you will pay $1000 less tax that year regardless of your tax bracket. A good example is the $1000 child tax credit. If your child applies and you don’t exceed the income limits, you get $1000 for each dependent child you claim on your tax return.

Common tax credits are the child tax credit, Hope Scholarship and Lifetime Learning Credits (education related), retirement savings credit, and the adoption tax credit.

{ 12 comments, please add your thoughts now! }

Related Posts


RSS Subscribe Like this article? Get all the latest articles sent to your email for free every day. Enter your email address and click "Subscribe." Your email will only be used for this daily subscription and you can unsubscribe anytime.

12 Responses to “Tax Credit vs. Tax Deduction”

  1. Brandon says:

    It is worth mentioning that some credits are refundable while others are not. A refundable credit will give you a refund if it reduces your tax liability below $0 while a non-refundable credit will be reduced if it would have made your tax liability below $0.

    Example:
    If I would be due to pay $900 in taxes in a year and receive a $1000 refundable credit, I would get all the money I had put in for taxes back and an additional $100. If the credit was non-refundable, I would only get the money I had put in for taxes back.

  2. Alisa says:

    There are some definite tax advantages in being a business owner. There are so many expenses that you may be able to deduct to reduce your taxable income. I just started my investment journey and as I am still learning so much about the stock market, I want to minimize any activities that would result in a taxabale event. Although, I believe, the tax amount is less where stocks are concerned, but, there is still a tax that must be paid if any income is generated. I am learning so much on this journey:

    Be well.

  3. Jim-

    Some deductions are worth more than others.

    Deductions that reduce Adjusted Gross Income (AGI), like Traditional IRA and 401(k) contributions and student loan interest, are much more valuable than itemized deductions like mortgage loan interest and charitable donations.

    This is because many deductions and credits are “phased out” or disallowed, and certain items of taxable income are increased, based on a taxpayer’s AGI.

    You indicate “If you are in the 25% tax bracket, a $1000 tax deduction means you will pay $250 less tax that year”. In the case of a deduction that reduces AGI a $1000 tax deduction could save you a lot more than $250 in federal income tax – possibly as much as $913!

    The Wandering Tax Pro

  4. jim says:

    Rob – That’s an excellent point and thank you for sharing it, you are totally right. Reduce your AGI and you might move the needle enough to get access to things you otherwise could’ve have, like Roth IRAs and the like.

  5. lillian says:

    For Bobert’s comment, I don’t get it! Why $250 in federal income tax – could be possibly as much as $913! Could you explain more. thanks!

  6. Gregg says:

    I’ve been following this pretty closely (probably too closely at times) and want to be sure I am not just reading how it works based on what I WANT it to do.

    In the event that you are due a tax refund, let’s say $1500, would the $7500 tax credit then result in a $9000 overall tax refund?

  7. Robert says:

    If it’s a refundable credit – The $7500 I mean. Say you haven’t claimed the credit yet, and you are already guaranteed the $1500. Then adding the refundable $7500 credit would result in a $9000 overall refund.

  8. tmartin says:

    Do you need to pay a tax credit back the following tax year? I remember 2-3 years ago we had a $500 tax credit (one of those stimulus checks), then the following year if you marked that you had received that then your refund that year went down by $500.

    • Gregg says:

      It really depends WHEN you purchased as to what type of credit it is.

      Initially it was $7500, to be repaid as part of your tax return for $500 a year, spread over 15 years.

      Then it switched to $8000 and did not have to be repaid. (Unknown to me, you also get interest on top of the $8000 from the date the IRS receives your amended return).

      Most recently there was a change where the $8000 (or a portion of it) could be used directly as part of your down payment.

      So to answer your question (somewhat), it depends on when you purchased!

      • tmartin says:

        Thanks Gregg for the info, but I actually referring to just tax credits in general, not the new home buyer credit – specifically one of the stimulus checks that were sent out during the Bush administration.

  9. Sadie says:

    Now retired and seeing the taxes I will owe on deductible Traditional IRAs once the Required Minimum Distribution (RMD)date begins (age 70.5), I wish I had paid the tax while employed & had “not taken” advantage
    of the deduction.

    While a ROTH IRA may not be deductible, being tax-free without RMD requirements would be wonderful at this stage in life!

  10. gloria says:

    which is worth more: $100 of tax deductions or $100 of tax credits and why so


Please Leave a Reply
Bargaineering Comment Policy


Previous Article: «
Next Article: »
Advertising Disclosure: Bargaineering may be compensated in exchange for featured placement of certain sponsored products and services, or your clicking on links posted on this website.
About | Contact Me | Privacy Policy/Your California Privacy Rights | Terms of Use | Press
Copyright © 2014 by www.Bargaineering.com. All rights reserved.