Tax Deductions vs. Tax Credits: Which is Better?

The Basics

When filing your taxes, you want to lower your tax liability as much as possible. Two main tools help you do this: deductions and credits. While they sound similar, they work differently.

Tax Deductions

A tax deduction lowers your taxable income. It reduces the amount of income that is subject to tax. For example, if you are in the 24% tax bracket and have a $1,000 deduction, you save $240 in taxes ($1,000 x 0.24). Common deductions include the Standard Deduction, Student Loan Interest, and 401(k) Contributions.

Tax Credits

A tax credit lowers your tax bill dollar-for-dollar. It is subtracted directly from the amount of tax you owe. For example, if you have a $1,000 tax credit, you save exactly $1,000 in taxes, regardless of your tax bracket. Common credits include the Child Tax Credit, Earned Income Tax Credit (EITC), and Solar Energy Credit.

The Verdict

Tax credits are generally better because they provide a dollar-for-dollar reduction. However, maximizing both deductions and credits is the key to paying the lowest legal amount of tax.