Tax Deduction vs. Tax Credit
Tax Deduction
A tax deduction reduces income subject to tax.
For each dollar of tax deduction, the reduction in tax liability is less than a dollar.
Assume that the tax rate is 15 percent and the tax deduction is $200.
| The Effect of Deductions on Income Subject to Tax | ||
|---|---|---|
| Without Deduction | With Deduction | |
| Income Subject to Tax | $10,000 | $9,800 |
| Tax at 15% | $1,500 | $1,470 |
At a 15 percent tax rate, a $200 tax deduction results in a $30 reduction in the tax.
Tax Credit
A tax credit is a dollar-for-dollar reduction in the tax liability.
For each dollar of tax credit, there is a dollar reduction in the tax liability.
Continuing with the example, assume that the tax credit is $200.
| The Effect of Deductions and Credits on Income Subject to Tax | ||
|---|---|---|
| Without Deduction With Credit | With Deduction Without Credit | |
| Tax | $1,500 | $1,470 |
| Tax Credit | -200 | 0 |
| Total Tax | $1,300 | $1,470 |
A $200 tax credit results in a $200 reduction in the tax liability. This is a dollar-for-dollar reduction in the tax liability.
With a $200 tax deduction, the total tax is $1,470.
With a $200 tax credit, the total tax is $1,300.
The taxpayer pays less tax with a $200 tax credit than with a $200 tax deduction.
