Tax Basics: Why Credits are Better than Deductions

We’re continuing our Tax Basics series with the best part of tax time, tax credits and tax deductions. Both reduce the taxes you owe, but they work in very different ways.

This week we’re focusing on the better of the two, tax credits. Why are they better? Because they reduce the taxes you owe, dollar for dollar, whereas a tax deduction reduces the income that you’re taxed on (more on this next week). So if you owe $2,000 in taxes a $500 credit reduces what you owe, dollar for dollar, to $1,500. A tax credit can be refundable or nonrefundable. A nonrefundable credit means that if you don’t owe a lot in taxes, you won’t get the full value if the credit takes your tax bill below zero. It will just stop at zero. A refundable credit goes beyond your tax liability and can result in a refund to you. The more well known credits are the Earned Income Tax Credit, Child Tax Credit and American Opportunity Tax Credit, which are all at least partially refundable. Some of the non-refundable credits include the Savers Credit, Senior Tax Credit and Residential Energy Credit, to name a few. Read our full article about tax credits here.

If you don’t qualify for any credits, you can still save money on taxes by utilizing any pre-tax accounts (401(k), HSA, FSA) that your employer may offer. And stay tuned for the final article in our tax series next week which is all about deductions.

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