Tax deductions and credits are the two main ways to reduce your taxes owed. But how do they work, and what’s the difference? Don’t fear, we have all your questions answered.
What is a tax deduction?
A tax deduction is an expense you can subtract from your gross income to lower your amount of income that will be taxed. One example is the standard deduction. If you reported $50,000 in income and took a standard deduction of $14,600, you could reduce your amount of taxable income by $14,600—leaving you with $35,400. You’d then be taxed on your income of $35,400 rather than $50,000.
What is a tax credit?
While tax deductions reduce your taxable income, tax credits directly reduce your taxes owed. For example, if you’re a parent who takes the Child Tax Credit, you can reduce your taxes owed by up to $2,000 for each child under 17. Other examples of tax credits include the Earned Income Tax Credit, the American Opportunity Tax Credit, and the Lifetime Learning Credit.
Some tax credits are refundable, meaning you can receive a refund even if you don’t owe any taxes in the first place. Others are not, so they can only reduce your taxes owed to zero, not get you a refund.
Which is better: a tax deduction or a tax credit?
Because credits directly reduce your taxes, they can get you bigger savings, so most people would rather take a credit than a deduction. For example, if you were faced with taking $100 in deductions or $100 in credits, you’d want to take the $100 in credits, as it would subtract $100 from your taxes owed.
A tax deduction will also reduce your taxes, but usually by less—if you were in the 24% tax bracket, for instance, $100 in deductions would only subtract $24 from your taxes. However, since you’ll likely never have to choose between a deduction and a credit, this question is purely hypothetical.
What’s the difference between itemized and standard deductions?
Most people will qualify for the standard deduction, although how much you’ll save with that depends on your filing status. On the other hand, there are many itemized deductions that not everyone will qualify for. Because you can choose to take either the standard or itemized deduction, you’ll want to weigh carefully which option will get you a bigger tax saving.
You may want to itemize if you have:
Charitable contributions
Medical and/or dental expenses that add up to over 7.5% of your adjusted gross income
Mortgage interest
Property taxes
State income taxes
State sales and local taxes
The standard deduction for 2024 is $14,600 if you’re single or $29,200 if you’re married filing jointly. That means if you take the itemized deduction, you’ll want to make sure that all your deductions add up to more than that amount overall.
For example, let’s say you’re married filing jointly, so your standard deduction amount is $29,200. Now let’s say you itemize your deductions, and the total adds up to $29,600. In this case, you’d want to take the itemized deductions option because it lowers your taxes by more.
About 90% of taxpayers today simply take the standard deduction, as it’s doubled in amount and many of the itemized deductions taxpayers could take in the past have been reduced or eliminated.
If you need help calculating your deductions or increasing your tax deduction, TaxGlobal can help! Use our tax calculators, ask Taby- our Q&A engine for everything taxes, giving you instant cited answers extracted directly from the IRS and other state-level official sources. And if that’s not good enough, connect with a tax and finance expert by visiting the discovery page in your TaxGlobal profile.