Tax Deduction vs Tax Credit
When navigating the complexities of personal finance, understanding the distinction between tax deductions and tax credits is crucial for optimizing your tax savings.
What is a Tax Deduction?
A tax deduction reduces your taxable income, which in turn lowers the amount of tax you owe. For example, if you earn $50,000 and have a $5,000 deduction, your taxable income becomes $45,000. Common deductions include mortgage interest, student loan interest, and medical expenses.
What is a Tax Credit?
A tax credit, on the other hand, directly reduces the amount of tax you owe, dollar for dollar. For instance, if you owe $1,000 in taxes and qualify for a $200 tax credit, your tax liability is reduced to $800. Tax credits can be either refundable or non-refundable, affecting how they impact your overall tax bill.
Key Differences
The primary difference lies in how they affect your tax liability. While deductions lower your taxable income, credits lower your tax bill directly. This makes tax credits generally more beneficial than deductions, as they provide a greater reduction in tax owed.
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