Both tax credits and tax deductions can reduce your tax bill and is one of the more confusing topics when it comes to taxes. Tax credits will directly reduce the amount of tax you owe the IRS and tax deductions reduce your taxable income reducing your tax liability. Depending on your tax bracket, this amount can vary for everybody.
Both credits and deductions can be claimed on your tax return if you meet the qualifications for each. Learn what it takes to meet the qualifying rules for these two tax benefits by reading below.
Quick Explanation of Tax Credits and Tax Deductions
| Tax Credits | Tax Deductions |
| Directly reduce the amount of tax you owe the IRS and some credits are refundable | Reduce your taxable income can vary on your tax bracket |
| Can be refundable, resulting in refunds | Won’t result in refunds unless they reduce your income to the amount overpaid through withholding or estimated tax payments |
| Some Credits are nonrefundable so they will lower your tax liability (solar panels and EV vehicles) | Generally, to fully/maximize these deductions you would need to itemize your return |
Tax credits reduce the tax liability you owe to the IRS and are treated as refundable payments made. Tax credits come in two forms: refundable and nonrefundable. Refundable credits are better as they can be refunded back on your return, while nonrefundable means they will only lower your tax liability.
Tax deductions are considered less valuable than credits as they can only reduce the amount of income you’re taxed on, but are still very helpful. There are two types of deductions the standard deduction which is preset every year by the IRS and this amount is a reduction on your total gross income.
The other type of deduction is itemizing and if you have more deductions that surpasses the standard, than you can itemize to lower your gross income to lower your total tax liability. You may only choose one, so depending on your situation it would be wise to review your options whether speaking to your tax professional or reviewing your situation.
Types of Tax Credits
Some of the most popular tax credits include:
• Adoption Credit
• American Opportunity Credit (for education expenses)
• Earned Income Tax Credits
• Child Tax Credit
• Child and Dependent Care Credit
• Credit for the Elderly or Disabled
• Lifetime Learning Credit (for education expenses)
• Credit for Other Dependents (for dependents who don’t meet the age requirements for the Child Tax Credit)
• Premium Tax Credit (for health insurance purchased in compliance with the Affordable Care Act)
• Saver’s Credit (for contributions made to retirement accounts)
Earned Income Tax Credit
The Earned Income Tax Credit (EITC) is the most commonly claimed tax credit, according to the Tax Policy Center. It’s designed to put money back into the pockets of low- to moderate-income taxpayers and reward them for working a job.
The EITC is refundable, but you can only qualify for it if your income is less than a certain limit. This has to be earned income you received from a job W-2 or 1099, this cannot be investment income or any income not earned by working.
Child and Dependent Care Credit
The Child and Dependent Care Credit reimburses taxpayers who have paid expenses for the care of qualifying dependents so they could work or look for employment. Adult dependents must be physically or mentally disabled and unable to care for themselves. Child dependents must be under age 13, or disabled and incapable of self-care if they’re 13 or older. Both parents must be working in order to qualify for this credit and you must have the EIN or social of the day care center.
Child Tax Credit
The Child Tax Credit applies to each of your child dependents who are under the age of 17 as of Dec. 31, the last day of the tax year. The child must live with you for at least half the year. They can’t have paid for more than half of their own support, such as in the case of a teenager who works and has income. Numerous other rules apply as well.
The Child Tax Credit allowed you to claim up to $3,000 for each qualifying child you had in tax year 2022 and an additional $600 for any child under the age of 6. The age limit was increased to age 17 by the last day of the year but don’t worry once the child passes that age as long as the child goes to college and is still your dependent you are still able to claim the child.
The Standard Deduction
The amount of the standard deduction is based on your age, income, and filing status: single, head of household, married filing separately, married filing jointly, or qualifying widow(er). It increases a little each year to keep pace for inflation. These are the standard deductions for 2021 (the tax return you’d file in 2022) and for tax year 2022.6
| Filing Status | Tax Year 2021 | Tax Year 2022 |
| Single | $12,550 | $12,950 |
| Head of Household | $18,800 | $19,400 |
| Married Filing Jointly | $25,100 | $25,900 |
| Married Filing Separately | $12,550 | $12,950 |
| Qualifying Widow(er) | $25,100 | $25,900 |
Itemized Deductions
You should consider itemizing if the itemized deductions you qualify to claim exceed the amount of your standard deduction for your filing status. Itemizing allows you to deduct certain expenses you paid during the tax year, subject to a variety of qualifying limits and rules. You must list these expenses on Schedule A and submit the schedule with your tax return when you file it.
The actual dollar value of these deductions can vary for different taxpayers depending on their income because deductions can only subtract from your taxable income, which determines your top tax bracket. Tax bracket percentages increase with the amount you earn.
Some commonly claimed itemized deductions include:
• Charitable contributions
• Medical and dental expenses
• Home mortgage interest
• State and local tax deduction limit
The mortgage interest deduction is limited to the interest paid on the first $750,000 of mortgages that are taken out after Dec. 16, 2017. This limit drops to $375,000 if you’re married and filing a separate return so do keep this in mind if you are living in a HCOL area such as California.
Best option for you?
Why not both? As long as you qualify each credit and deduction, it would be wise to run the numbers to ensure you minimize your tax liabilities. Every amount you can save will add up and in the long run can help you plan and set up a strategy for future success.
You can always research and do your due diligence or even ask a tax professional if you’re not sure what tax credits you might be eligible to claim. Some types of tax software, such as TurboTax, will help you determine what you qualify for as well so don’t miss out.
