Tax Deduction vs. Tax Credit

Tax Deduction

A tax deduction reduces income subject to tax.

For each dollar of tax deduction, the reduction in tax liability is less than a dollar.

Assume that the tax rate is 15 percent and the tax deduction is $200.

The Effect of Deductions on Income Subject to Tax
	Without Deduction	With Deduction
Income Subject to Tax	$10,000	$9,800
Tax at 15%	$1,500	$1,470

At a 15 percent tax rate, a $200 tax deduction results in a $30 reduction in the tax.

 

Tax Credit

A tax credit is a dollar-for-dollar reduction in the tax liability.

For each dollar of tax credit, there is a dollar reduction in the tax liability.

Continuing with the example, assume that the tax credit is $200.

The Effect of Deductions and Credits on Income Subject to Tax
	Without Deduction With Credit	With Deduction Without Credit
Tax	$1,500	$1,470
Tax Credit	-200	0
Total Tax	$1,300	$1,470

A $200 tax credit results in a $200 reduction in the tax liability. This is a dollar-for-dollar reduction in the tax liability.

With a $200 tax deduction, the total tax is $1,470.

With a $200 tax credit, the total tax is $1,300.

The taxpayer pays less tax with a $200 tax credit than with a $200 tax deduction.