The Difference Between a Tax Deduction and a Tax Credit

There are two ways of lowering how much you owe the Federal government when it comes to taxes: the tax deduction and the tax credit. Understanding the difference between the two can be helpful for many people, especially those who prefer to do their own taxes.

Tax deduction

Tax deductions reduce how much you owe in taxes by decreasing your income. This can put you down into a lower tax bracket, and that means that you will owe less in terms of taxes. There are two types of tax deductions that lower your income:

1. Figuring adjusted gross income. This type of tax deduction comes before you figure out your tax bracket. This is all that stuff that fill in on the front of your Form 1040 to get from the number on your earned income down to your adjusted gross income.
2. Deductions from your adjusted gross income. When you flip your Form 1040 over, the first space is for your adjusted gross income. You then begin taking more deductions from there. You either take itemized deductions (Schedule A) or the standard deduction (which depends on your filing status -- married, single, etc.) . You also get the dependent deduction and other deductions at this point.

Tax credit

Next is the tax credit. Tax credits are figured after you determine your tax bracket, and how much you should owe in taxes. A tax credit is a dollar for dollar reductions in the amount of tax you owe. You figure out how much tax you owe, and then the credits work as if you are applying a gift card for a certain amount to reduce how much you need to pay.

It is interesting to note that tax credits are the same for everyone, and tax deductions are not. In many cases, a tax deduction varies according what your income level is. However, a $300 tax credit is a $300 tax credit, no matter your income level.

Qualifying for tax credits and deductions

It is important to note that not everyone qualifies for certain tax deductions and credits. If you make more than a certain amount of money, some credits and deductions, such as for savings accounts, Earned Income Credit and other tax lowering credits and deductions, are not available to you. There are worksheets available to help you determine whether or not you can take a certain tax credit or tax deduction.

You can also contact the IRS for more information. The IRS Web site is www.irs.gov, and is very helpful.