Home Financial Information Tax Credit vs. Deduction: Learn The Differences [2021]

Tax Credit vs. Deduction: Learn The Differences [2021]

by Team Finance Meaning
Tax Credit vs. Deduction

Everyone wants to save some money everywhere possible. One way to keep your money is by paying fewer taxes and that too, not by fraud. Comparing Tax credit vs. deduction may make it straightforward for you how it is possible to save money from taxes.

Are you also looking to save money? Do you also have some life goals, such as buying an Audi A 3 or the best gaming computer? This article might help you know how to save money by lessening your payable tax amount.

Have you ever heard about Tax Credits or Tax Deductions? Well, these are the two ways that may protect you from paying higher taxes. In this article, we will discuss how these work and what the differences are between them. Read the article entirely and select the best option.

Tax Credit vs. Deduction: Overview

Knowing the difference between a Tax credit and tax deduction is essential to know which one of the above is beneficial. Though both benefit you by reducing your payable tax, the difference is how they work to reduce your tax.

Some people find tax credit beneficial, while others think that tax deduction might be more helpful. However, you may select the one after the comparison of tax credit vs. tax deduction. You may also apply for both after checking your eligibility.

On the other hand, both might seem the same to some people, but they are not. Read the entire article to clear your ambiguities regarding the difference between a tax credit and a tax deduction.

Tax Credits

Though tax credits can reduce your total payable tax, not everyone is eligible for tax credits. The government offers such opportunities to companies and organizations to lower their payable taxes to use this money in something positive.

Such companies which get a tax credit are supposed to do some positive acts such as running campaigns and increasing their productions. If your company is also performing such actions, you can quickly get eligibility for a tax credit.

What Is It?

The difference between tax credit and tax deduction is always a problem for many people. However, it is not very complex. Tax credits simply reduce the amount of tax that you have to pay. If you are eligible to pay some tax, tax credits may decrease it by a certain number.

Suppose you buy a product from an online store such as Amazon. It costs you 50 dollars, but you used a 10 dollar coupon. Now you have to pay only 40 dollars instead of 50. Tax credits work in the same way. It subtracts a number from your total payable tax.

Types of Credits

To summarize, there are three main types of tax credits. Refundable, Non-refundable, and partially refundable. Let’s discuss each of them in detail.

Non-Refundable Tax Credits

A non-refundable credit can not get you any refund. You can only get a discount of up to 0 dollars. If you owe something to the government, the government will not give you any refund for that. Common examples of non-refundable credit include mortgage interest, child adoption tax credits, and Child and Dependent credit.

Let’s take an example. Imagine you have bought a product worth 7 dollars. You use a 10 dollars coupon to reduce your payable amount. After using a 10 dollar coupon for a 7 dollars product, the shopkeeper owes you 3 dollars. But he didn’t give you three dollars back.

Refundable Tax Credits

In a refundable tax credit, the government pays you a refund if it owes you some money. If your credit goes below 0 dollars, the government will pay you for every dollar below 0 dollars.

Taking the example of a store may make it easy to understand. Suppose you buy something for 7 dollars and use a 10 dollar coupon. Now according to refundable tax credits, the shopkeeper will pay you the remaining 3 dollars.

Partially Refundable Tax Credits

It depends on whether the government would give you a complete refund or a no refund. Sometimes, the government pays back a full refund, while it doesn’t provide any refund in other cases.

For example, the shopkeeper says that if your total payable money is less than 5 dollars, he will not pay it to you. Similarly, the government has some limits under which it doesn’t provide a refund. However, as the limit exceeds, the government gives you a full refund.

Understanding Tax Credits

To understand tax credit in simple words, we can say that it is the amount of money the government allows you to subtract from your payable taxes. The more tax credit you get, the fewer taxes you have to pay. If your tax credit exceeds your payable tax, the government may also give you a refund.

Let’s take an example. Suppose you have to pay a 5000 dollars tax. The government allows you a tax credit of 2000 dollars. Now, you don’t have to pay a 5000 dollars tax. Instead, you just have to pay 3000 dollars as you have a 2000 dollars coupon.

Tax Deductions

Tax Deductions also decrease your payable taxes, but differently, a tax credit does. Although the result of both tax credits and deduction is the same (less payable taxes), both work differently. Let’s dive into the details of tax deductions and see how it works.

What Is It?

What is a tax deduction? A tax deduction decreases your total taxable income. Unlike tax credits, tax deduction does not directly reduce your taxes. However, it lowers your income on which you might be taxed.

Tax deductions are also of two types. A standard deduction is the fixed amount of deduction that can not be changed and doesn’t need calculations. However, itemized deductions may be a bit trickier and need measures every time you pay taxes.

Understanding Tax Deductions

Understanding tax deductions is not difficult. However, it may be trickier. In simple words, a tax deduction reduces the total income on which you have to pay taxes. For example, if your total income is 25000 dollars. The government will take some tax from you for 25000 dollars.

However, if you have deductions, your income might decrease. Let’s suppose you have a 7000 dollars deduction. Now the total amount on which you have to pay taxes would be 18000 dollars. Isn’t it a great deal to pay fewer taxes when you are eligible for it?

Tax Credits Vs. Deductions: Which One Is Better?

The main goal of both tax credit and the tax credit is the same, i.e., lowering your payable taxes. However, both work differently. Now it depends on you, which one you want to select.  A tax credit directly gives you some discount on your total payable tax.

On the other hand, a tax deduction reduces your income to lower your payable tax. Both are beneficial, but the tax credit is often best for companies and organizations. Individuals may get more benefits from the tax deductions than tax credits.

Frequently Asked Questions (FAQs)

Is a tax deduction or credit better?

Both tax deduction and credit reduce your total payable tax. However, both do it differently and also have a bit different results. A credit tax gives you a refund for your withholding, and it may give you a refund even if you don’t have a withholding.

Which is better, exemptions, deductions, or credits?

Exemptions and deductions work almost similarly, while credits work somehow differently. Credits decrease your tax bill, while the other two reduce your total payable tax. Exemptions and deductions reduce your tax according to your tax bracket, while credits have nothing to do with the brackets. It reduces your bill dollar to dollar.

Is the tax credit a deduction?

Though tax credit is a deduction in your total payable tax, the tax deduction is something different. There is a minimal difference between them, but one might understand it with a bit of focus. A tax deduction is a dollar-to-dollar reduction in your tax, while the tax credit is the reduction in your total income tax.

What deductions can I claim without receipts?

You can claim deductions for your travel, phone calls, training, books, and much more without any receipts. However, a condition of fewer than 300 dollars applies. Your total deduction must be no more than 300 $ if you want to claim deductions without receipts.

What tax deductions can I claim?

You can claim tax deductions for almost all your withholdings. However, the most common tax deductions that you can claim include lifetime learning, Student loan, Child tax, Adoption credit, and more. You can also claim deductions for medical expenses and mortgage tax.

Final Comments: Tax Credit Vs. Deduction

Well! That’s all about the comparison of Tax credit vs. deduction. Both are beneficial as they can lower your total payable taxes. Though both work differently, the result is always the same, i.e., (lower your payable taxes).

So, in this article, we tried our best to differentiate tax credits from tax deductions. However, it is tricker to recognize their difference. If you are still confused about these, reread the article. You may also ask us in the comment section about any of your confusions.

You may also like