Difference between Tax Credit and Tax Deduction

Key Difference: The tax credit is an amount that is deducted from the amount of tax that is to be paid by a person, whereas the tax deduction is an amount that is deducted from the total income of the person; as the total income decreases, so does the tax deductable.

 Taxes are an important and a confusing part of adult life. Not only do you have to give part of your hard earned money to the government, but what makes the process worse is that it is not straightforward. Once, you adjust to the fact that you have to pay taxes; there are things like tax credits and tax deductions thrown into the mix, as if things weren’t complicated enough.

At the end of the matter, both tax credits and tax deductions reduce the amount of tax that one has to pay to the government. However, they work in two very different ways. A tax credit works directly to reduce the tax that a person has to pay, whereas a tax deduction works indirectly.

According to Investopedia, a tax credit is amount of money that a taxpayer is able to subtract from the amount of tax that they owe to the government. Whereas, a tax deduction is a deduction from gross income that arises due to various types of expenses incurred by a taxpayer. Basically, this means that the tax credit is an amount that is deducted from the amount of tax that is to be paid by a person, whereas the tax deduction is an amount that is deducted from the total income of the person; as the total income decreases, so does the payable tax.

Hence, both reduce the tax but in different ways; one directly, the other indirectly. However, due to how they work, the tax credit usually offers more savings, then tax deduction. Also, the tax credit is usually calculated on the basis on taxes already paid and also encourages behaviors like investment or parenting, as these are usually eligible for tax credit. Tax deduction, on the other hand, is usually calculated on expenses, particularly those that are incurred to produce additional income.

Comparison between Tax Credit and Tax Deduction:

 

Tax Credit

Tax Deduction

Description (Investopedia)

An amount of money that a taxpayer is able to subtract from the amount of tax that they owe to the government.

A deduction from gross income that arises due to various types of expenses incurred by a taxpayer.

Type of

Tax incentive

Reduction of income

How it works

Directly reduces tax bills

Indirectly reduce tax bills

Reduction

Reduces the tax you have to pay

Reduces the income on which the tax is calculated

On the basis of

Taxes already paid or to encourage behaviors like investment or parenting

Expenses, particularly those incurred to produce additional income

Amount

Usually more than tax deduction

Usually less than tax credit

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