Tax Credit vs. Tax Deduction (Example)Personal Taxes
While a tax deduction reduces the amount of your income subject to a particular tax, a tax credit reduces the amount of tax itself.
Tax Credit vs. Tax Deduction Example
Let’s say that without any deductions or credits, your taxable income is $100,000.
If you’re single, your tax liability for tax year 2022 would be $17,835, and you’d be in the 24% tax bracket.
Now let’s say you qualify for and take a $1,000 tax deduction as well as a $1,000 tax credit.
Taking into account the $1,000 tax deduction, your taxable income would be $99,000, and your tax liability before credits would be $17,595 — exactly $240 less than your tax liability before taking the credit.
This is because you’re in the 24% tax bracket, and $100,000 x 24% = $240.
So, in general, a tax deduction will reduce your tax liability by the amount of the deduction multiplied by your marginal tax rate.
Now, what about the $1,000 tax credit? Tax credits reduce the amount of your tax liability itself, so thanks to the $1,000 tax credit, your tax liability would be reduced from $17,595 to $16,595.
So, in general, a tax credit is much more valuable than a tax deduction.
Examples of Tax Credits
Here are some common tax credits.
- Child Tax Credit: This is a tax credit for families with qualifying children. For tax year 2022, children must be under the age of 17, and the maximum credit is $2,000 per child.
- American Opportunity Tax Credit: This is a tax credit available for students or those who claim them as dependents for qualified education expenses paid for the first four years of higher education. For tax year 2022, the maximum credit amount is $2,500 per eligible student.
- Saver’s Credit: This is a tax credit available for taxpayers who contribute to certain retirement plans during the year. Your income has to be relatively low to qualify for the credit, and the maximum credit for the year is $2,000 for married taxpayers filing jointly and $1,000 for other taxpayers.
Examples of Tax Deductions
Here are some common tax deductions:
- Standard Deduction: This is a deduction that everyone is entitled to depending on their age, blindness status, dependency status, and filing status. In lieu of the standard deduction, taxpayers can choose to deduct the sum of their itemized deductions, which makes sense if the sum of their itemized deductions exceed their standard deduction amount for the year.
- Charitable Contribution Deduction: This is an itemized deduction for donations made to qualifying organizations.
- Traditional IRA Contribution Deduction: This is a non-itemized deduction for contributions made to a traditional IRA. The maximum deduction for tax year 2022 is $6,000 ($7,000 for taxpayers age 50 or older). There are special rules if you or your spouse are eligible to contribute to a retirement plan at work.
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.