When you file taxes every year, you have the opportunity to claim any credits and deductions you may be eligible for. Obviously these are two different things – but if you’re like most people, you probably don’t puzzle too much over that difference.
After all, the end result is the same: both deductions and credits will save you money on taxes. But the difference between the two can actually have big implications.
Fortunately, it’s also pretty straightforward: a deduction reduces your total amount of taxable income, while a credit directly reduces the amount of tax you have to pay.
A nice piece of trivia, but… so what? Well, if you look at how those transactions play out in this example, it quickly becomes clear that one saves you more on taxes than the other one does, in general anyway:
While a $3,000 tax deduction sounds pretty nice, it’s important to remember that that $3,000 is going to be diluted through the tax calculation process. A $3,000 tax credit, on the other hand, means $3,000 less of taxes, full stop.
To be clear though, I’m telling you to go out and get yourself a nice juicy tax credit. For one thing, you often won’t have much choice in the matter – e.g., you can’t claim a child tax credit if you don’t have kids (not that some people won’t try).
For another thing, the outcome will vary wildly according to your specific situation. In some cases, you’ll fare better with a generous tax deduction than with a skimpy tax credit.
But all other things being equal, a tax credit will give you more dollar-for-dollar savings than a deduction will. So when April rolls around, be sure you’re not missing any that you could be eligible for!