- Tax credits and tax deductions can both lower your income tax liability.
- A tax deduction lowers your taxable income for the year.
- A tax credit is applied to your income tax bill, and some are even refundable.
Tax credits and tax deductions each offer a way to pay less income tax. But the two options have different mechanisms for reducing your income tax liability.
While tax deductions reduce the amount of income you have to pay taxes on, tax credits directly reduce what you owe. Here's a breakdown of the differences between the two.
Tax credits: Dollar-for-dollar reduction
A tax credit is a dollar-for-dollar reduction of your tax bill. For example, if your total tax bill is $5,000 and you claim a credit worth $2,500, you will only need to pay $2,500 in taxes.
"They come in two flavors — refundable and non-refundable," says Rob Burnette, a financial advisor and CEO of Outlook Financial Center. A refundable tax credit means that if it's applied to your tax bill and there's money left over, you'll receive it as a refund.
Meanwhile, Burnette says, "non-refundable credits will reduce your tax burden to zero, but no excess tax credit is paid."
Here's a look at some most common federal tax credits:
- Lifetime Learning Tax Credit (LLC): This non-refundable credit can be worth up to $2,000 for those who paid for courses in undergraduate, graduate, or professional school.
- American Opportunity Tax Credit (AOTC): This credit offsets expenses for higher education up to $2,500 per eligible student, and 40% of the credit is refundable.
- Earned Income Tax Credit (EITC): This fully refundable tax credit is designed to benefit workers with low to moderate income, giving them a credit worth between $632 and $7,830, depending on their filing status and the number of qualifying children they have.
- Child Tax Credit (CTC): This refundable tax credit is worth up to $2,000 per dependent under age 17, $1,600 of which may be refundable.
Important: To qualify for various tax credits and deductions — with the exception of the standard deduction — you have to meet certain eligibility requirements in terms of income, age, and dependency status.
Example of a tax credit
Start by determining how much you owe in income taxes based on your annual income. Once you arrive at your total tax bill for the year, it's time to apply tax credits.
Let's say your total federal tax bill is $2,000, and you qualify for $2,500 in refundable tax credits. Instead of paying $2,000 to the IRS, you'll receive a tax refund of $500.
Tax deductions: Lowering your taxable income
A tax deduction reduces your taxable income for the year, helping you pay less in taxes. Importantly, tax deductions aren't refundable.
All taxpayers qualify for a standard deduction, regardless of their income level. Here are the standard deduction amounts for 2024 and 2025
Filing status | Standard deduction for 2024 (taxes you file in 2025) | Standard deduction for 2025 (taxes you file in 2026) |
Single | $14,600 | $15,000 |
Married, filing jointly | $29,200 | $30,000 |
Married, filing separately | $14,600 | $15,000 |
Head of household | $21,900 | $22,500 |
Some taxpayers who have large medical expenses, make large charitable donations, or pay a lot of mortgage interest and local taxes may choose to itemize their deductions instead of claiming the standard deduction so that they can cut their taxable income by an even larger amount.
Here's a look at some of the most common deductions that taxpayers can claim, whether they take the standard deduction or itemize:
- Student loan interest deduction: If you are paying off federal student loans, you may be able to deduct up to $2,500 in interest payments each year.
- Retirement contributions: As you save for retirement, you may tuck away funds into a traditional IRA or employer-sponsored plan and deduct the amount saved up to the annual limit.
- Health savings account (HSA) contributions: If you qualify to save for healthcare expenses through an HSA, you can claim your contributions as tax deductions.
- Self-employed tax deductions: If you are self-employed, you can deduct eligible business expenses from your income. A few expenses you might choose to deduct include your home office, your phone bill, half of the self-employment tax, health insurance, and business travel.
Quick tip: Working with a tax professional can help you uncover potential savings in the form of tax deductions or tax credits.
Example of a tax deduction
Let's say your income for the year is $50,000. If you are a single filer taking the standard deduction of $14,600, then your taxable income for the year would be $35,400. You would calculate your income tax on this amount.
Key differences: Credits vs. deductions
Tax credits and tax deductions can help you reduce your annual tax bill if you fall within certain income ranges. But the process of using tax credits and tax deductions is different.
- Tax credit: A tax credit reduces your tax bill on a dollar-for-dollar basis. You claim it once your tax bill has been calculated. If you don't owe any tax, refundable credits can put money back in your pocket.
- Tax deduction: A tax deduction is an amount that you can subtract from your gross income or your adjusted gross income (AGI) before calculating your tax bill. It lowers the amount of your income that's taxable, and could potentially lower your marginal tax rate.
Which is better: Credit or deduction?
A tax credit is money subtracted from your income tax bill. Since some credits are refundable, you could get money back even if you didn't owe any tax. That can make tax credits more valuable than tax deductions, which can reduce your tax bill to zero but not result in a refund.
Ultimately, claiming a combination of tax credits and deductions will yield the greatest tax savings. It's smart to work with a tax advisor if you have several income sources, business expenses, or an otherwise complicated financial situation to ensure you don't miss any credits or deductions.
FAQs about tax credits vs. deductions
Can I claim both tax credits and deductions?
Yes, you can claim both tax credits and deductions if you meet the eligibility requirements. A combination of both will help lower your tax liability.
How do I know which credits and deductions I qualify for?
You can find out which credits and deductions you qualify for by reviewing online IRS resources or preparing your taxes with tax software. You may also want to consult a tax professional if you have complicated finances, such as income and expenses from a business.
Are there any limitations on how many tax credits I can claim?
There are no limitations on the number of tax credits you can claim if you qualify. However, you may not see any benefit if they aren't refundable and your tax bill has already been reduced to zero.