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

Introduction

Understanding the difference between tax credits and deductions is essential for maximizing your
tax savings. While both reduce your tax liability, they work in different ways.

• Tax deductions lower your taxable income, reducing the amount of income subject to tax.
• Tax credits directly reduce your tax bill, providing a dollar-for-dollar reduction.

This guide explains how tax credits and deductions work, their key differences, and how to maximize
them in 2025.

 What Are Tax Deductions?

How Tax Deductions Work (IRC §162 & §170)

• Reduce your taxable income, which lowers the amount of income that is taxed.
•  The actual savings depend on your tax bracket.

Example:

•  If you have $50,000 in taxable income and claim a $5,000 deduction, your taxable income is
  reduced to $45,000.
• If you are in the 22% tax bracket, the deduction saves you $1,100 in taxes ($5,000 × 22%).

Types of Tax Deductions

Standard Deduction (IRC §63)

•  The IRS allows taxpayers to deduct a fixed amount from taxable income without itemizing.
• For 2025, the standard deduction is:
• $15,200 for single filers
•  $30,400 for married filing jointly
•  $22,800 for head of household

Itemized Deductions

If your itemized deductions exceed the standard deduction, you can list expenses on Schedule A
(Form 1040), such as:

•  Mortgage interest (Form 1098)
• State and local taxes (SALT)
•  Medical expenses (if exceeding 7.5% of AGI)
•  Charitable donations (Form 8283)

Action Step: Choose between the standard deduction or itemizing based on which option provides
the highest deduction.

 What Are Tax Credits?

How Tax Credits Work (IRC §25 & §32)

• Tax credits reduce your total tax bill dollar-for-dollar.
•  Some credits are refundable, meaning you can receive money back even if you owe no
  taxes.

Example:

•  If your tax bill is $3,000 and you claim a $1,000 tax credit, your tax liability is reduced to
  $2,000.

Types of Tax Credits

Refundable Tax Credits

Refundable tax credits can reduce your tax liability to zero and provide a refund if your tax bill is
lower than the credit amount.

• Earned Income Tax Credit (EITC) – Form 1040, Schedule EIC
• Child Tax Credit – Form 1040, Schedule 8812
•  Premium Tax Credit for Health Insurance – Form 8962

Non-Refundable Tax Credits

These credits reduce your tax liability but do not generate a refund if the credit exceeds your total
tax due.

•  Lifetime Learning Credit – Form 8863
•  Saver’s Credit (Retirement Contributions) – Form 8880
• Foreign Tax Credit – Form 1116

Action Step: If eligible, claim refundable credits first to maximize tax savings.

 Tax Credits vs. Deductions: Key Differences

Example:

•  If a taxpayer in the 22% tax bracket claims a $2,000 deduction, they save $440 in taxes
  ($2,000 × 22%).
•  If they claim a $2,000 tax credit, their tax bill is reduced by $2,000.

Conclusion: Tax credits are generally more valuable than deductions because they provide dollar-
for-dollar tax savings.

 How to Maximize Tax Credits and Deductions

Step 1: Determine Whether to Take the Standard or Itemized Deduction

•  Use the standard deduction if it is higher than your total itemized deductions.
•  If you have high mortgage interest, medical expenses, or charitable contributions, itemizing
  may save more.

Step 2: Claim All Available Tax Credits

• Check eligibility for education, retirement, and dependent-related credits.
•  Use Form 8863 for education credits, Form 8880 for the Saver’s Credit, and Form 1040

Schedule 8812 for the Child Tax Credit.

Step 3: Track Business and Work-Related Expenses

• If self-employed, deduct expenses such as home office costs, business meals, and travel
  using Schedule C (Form 1040).
• Use Form 4562 for depreciation if you purchased business equipment.

Step 4: Use Tax-Advantaged Accounts

•  Contribute to 401(k), IRA, or HSA accounts to lower taxable income.
•  Contributions to HSA plans (Form 8889) are tax-deductible and grow tax-free.

Step 5: Consult a CPA for Tax Planning

•  A CPA can identify additional deductions and credits that you might miss.
•  They can also optimize tax strategies for long-term savings.

Frequently Asked Questions (FAQs)

1. Is a tax deduction or tax credit better?
A tax credit is more valuable because it reduces your tax bill directly, while a deduction only
reduces taxable income.

2. Can I claim both tax deductions and credits?
Yes, you can claim both deductions and credits as long as you qualify for them.

3. What is the biggest tax deduction for most taxpayers?
The standard deduction is the largest for most taxpayers unless they qualify for large itemized
deductions.

4. Are business expenses tax credits or deductions?
Business expenses are deductions that lower taxable income.

5. Can I get a refund if my tax credits exceed my tax bill?
Yes, if the credits are refundable, you may receive a refund even if you owe no taxes.

 Conclusion

Understanding the difference between tax deductions and credits is crucial for maximizing your tax
savings. While deductions lower taxable income, credits directly reduce your tax liability. The best
tax strategy involves claiming all eligible deductions and maximizing refundable credits to lower
your overall tax burden.

For expert tax planning, schedule a meeting with our CPA Anshul Goyal by clicking at
https://calendly.com/anshulcpa/ now.

 About Our CPA

Anshul Goyal, CPA, EA, FCA, is a licensed Certified Public Accountant in the United States and an
Enrolled Agent admitted to practice before the IRS. He specializes in tax planning, IRS compliance,
and business tax strategies for individuals and corporations.

 Disclaimer

This article is for informational purposes only and should not be considered tax or legal advice. Tax
laws change frequently, and individual circumstances vary. Consult a qualified CPA or tax
professional before making any tax-related decisions.