Tax Deductions Vs Credits

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Both a tax deduction and a tax credit reduce the amount of income taxes paid, but in different ways and with different effects on your bottom line.

Deductions reduce how much you owe in taxes by actually decreasing your income. For example, you might have a $1,500.00 medical deduction from your personal gross income.. If high enough, these tax reductions can even place you in a lower tax bracket, thus reducing your taxes even more.

Credits are a dollar-for-dollar reduction in the amount of income tax you actually pay. It is deducted after you compute your taxable income. A 30% tax credit on a $5,000 solar hot water installation will actually reduce the taxes you pay by $1,500.00.

If you’re in the 25% bracket, a $1,500.00 deduction lowers your tax bill by $375.00 or $300.00 if you are in the 20% tax bracket.

But a $1,500.00 tax credit lowers your tax bill by the full $1,500, no matter what your tax bracket.

Think of a tax credit as your gift card from Uncle Sam which reduces the total income tax paid by the entire amount of the credit rather than just a percentage..

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