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Understanding your taxes can feel overwhelming, especially when dealing with a variety of tax terms. Two of the most common terms used when doing taxes are “deduction” and “credit.” While they feel similar, they are different, and it can be challenging to understand the difference between the two and how they influence your taxes.

Here is a breakdown of the definitions of a tax deduction and tax credit and the key differences between the two.

Deductions: Lowering Your Taxable Income

Think of deductions as discounts before you get the bill. Deductions are reductions made to your income before taxes are calculated, reducing the amount of your income subject to taxation, ultimately decreasing your tax bill.

Eligibility

Everyone is eligible for the standard deduction. However, if you are opting to itemize your deductions instead, then you have to take into consideration which deductions you’ll be eligible for, as each deduction’s criteria is different.

Refundability

Deductions are not refundable unless you overpay on your estimated taxes.

Examples

There are two methods for taking deductions: taking the standard deduction or itemizing your deductions. Common itemized deductions include mortgage interest, charitable donations, and certain business expenses.

Credits: Direct Dollar-for-Dollar Reductions

Think of tax credits as coupons directly applied to your tax bill. Credits are reductions made to your tax bill. Each dollar of the credit reduces your tax liability by exactly $1.

Eligibility

There are many tax credits valued at different dollar amounts. However, each tax credit has specific eligibility criteria. The eligibility criteria are different from tax credit to tax credit. They may include income, age, or specific types of purchases.

Refundability

Some credits are refundable, even if you’re not obligated to pay taxes.

Examples

Some of the most common credits include the Earned Income Tax Credit (EITC), the Child Tax Credit, and Solar Energy Tax Credits.

Which is Better?

There’s no universal winner because they don’t play for opposite teams. Your tax strategy may include both tax deductions and tax credits. (However, some tax deductions and tax credits cannot be used together.) It depends on your individual circumstances and tax situation. This is where having a tax prep professional can be beneficial. They can analyze your situation and recommend the most effective strategy.

Have questions about credits or deductions and how they impact your unique tax situation? Our team of tax planning and prep experts are here to help. Contact us.