Tax Credits vs. Tax Deductions
By: Chase Howard
Tax Deductions vs. Tax Credits
Today we’re diving into something that could literally save you thousands of dollars—yep, we’re talking taxes. More specifically, tax deductions vs. tax credits—two terms you’ve probably heard tossed around a lot, but maybe not fully understood.
Don’t worry, you’re not alone.
A lot of people confuse the two or assume they’re basically the same thing. But knowing the difference—and more importantly, knowing how to use them strategically—can seriously impact your wallet. So let’s break it all down in a way that actually makes sense.
By understanding and maximizing tax deductions and credits, you can reduce what you owe—or boost your refund. And who doesn’t love that?
What Are Tax Deductions?
Deductions reduce your taxable income—in other words, they lower the income amount the IRS uses to calculate how much you owe in taxes.
Let’s say you made $90,000 this year. That’s your income, but it’s not necessarily what you’ll pay tax on. Thanks to deductions, you might only be taxed on $70,000—or even less.
Some deductions show up automatically, like those for 401(k) or HSA contributions made through your employer. Others, you’ll have to enter yourself when filing.
There are two main types of deductions:
1. Above-the-Line Deductions
These appear early on your tax form and include things like student loan interest, traditional IRA contributions or HSA contributions made outside of payroll.
2. Below-the-Line Deductions
This is where you choose between taking the Standard Deduction (a fixed amount based on your filing status) or Itemized Deductions (based on actual expenses like mortgage interest, property taxes, charitable donations, and certain state taxes.)
You only itemize if your total itemized deductions exceed the standard deduction. For example, in 2024, the standard deduction for married couples filing jointly was $29,200. If your itemized expenses don’t exceed that, the standard deduction is the way to go.
What are Tax Credits?
Tax credits are even more powerful than deductions. Instead of reducing your taxable income, credits reduce your actual tax bill—dollar for dollar.
Two Types of Credits:
1. Non-Refundable Credits
These reduce your tax liability but won’t get you money back beyond wiping out what you owe. Examples include:
- Lifetime Learning Credit
- Energy efficiency home improvement credits
- Saver’s Credit
2. Refundable Credits
These can reduce your tax to zero—and pay you the difference if there’s extra left over. Examples include:
- Earned Income Tax Credit
- Child Tax Credit (up to $2,000 per child under 17)
- American Opportunity Credit (for education)
Let’s say you owe $1,000 in taxes, but you qualify for a $2,000 refundable credit. You’d get a $1,000 refund back from the IRS. Pretty sweet, right?
Deductions vs. Credits
Tax Deductions
- Lower your taxable income
- Apply before your tax is calculated
- Can be the standard deduction or you may itemize. Whichever is more.
- Lower your tax owed
Tax Credits
- Reduce your actual tax owed
- Apply after your tax is calculated
- Refundable and non-refundable
- Can result in refunds
A Few Final Thoughts
One last heads-up: the IRS loves to change things. Credit amounts, income limits, deduction rules—they’re updated regularly. That’s why it’s a good idea to check in with a tax professional each year or stay on top of IRS updates yourself.
If you’re unsure what applies to you, or if you’re making the most of your deductions and credits, don’t hesitate to reach out. At Pack Tax, we’re always happy to help clarify what’s best for your specific situation.