Many taxpayers are unclear on the difference between deductions and credits. Both can be powerful tax-saving tools. Here’s how they each work:
Deductions lower a taxpayer’s taxable income before the tax is calculated. For instance, on an individual return, you can either claim the standard deduction or itemize deductions, depending on which option reduces your taxable income more. Credits directly reduce the tax due, dollar for dollar, making them more valuable than deductions of the same dollar amount. Some credits, such as the Child Tax Credit, are partially or fully refundable, meaning that if the credit exceeds the tax owed, the taxpayer may receive some or all of the difference as a refund.