The difference between a tax deduction and a tax credit

On Behalf of | Mar 30, 2017 | Tax Controversies

For those who are Shakespeare historians, the phrase “beware the ides of March” continues to have significance. We hope that the middle of March came and went without any significant issues for our readers. However, for those still struggling to complete their federal income tax returns, it is the ides of April that may be cause for concern.

Indeed, completing one’s taxes in a timely fashion may not be an issue, but ensuring that calculations are correct may be problematic; especially if there is a disconnect between the difference between a tax credit and a tax deduction.

If this describes your plight, you are certainly not alone. Many people don’t quite understand the difference between a tax credit and a tax deduction. This post will briefly explain. 

When you are entitled to a tax credit, you are given a “dollar for dollar” reduction of the taxes you would have been required to pay based on your income. So, for example you qualify for a $1500 tax credit based on the purchase of certain appliances, you would be entitled to a $1500 reduction in your income taxes. This credit would be balanced against taxes you may have already paid (through withholdings from your paycheck or quarterly payments from a business). If you have paid too much in taxes, you may be entitled refund.

Similarly, a tax deduction saves you money based on your applicable tax rate. So if the same $1500 tax credit only qualifies as a deduction, and you are subject to a 33 percent tax rate, your tax savings would likely only be $495 instead of $1500. Given the stark difference, it is important to know the difference between the two.

If you have additional questions, an experienced tax attorney can help.