Tax Credits vs Tax Deductions: What’s the Difference & Which Saves More Tax

Are you confused about the difference between tax credits vs tax deductions? You’re not alone! In this video, we break down what each one means, how they affect your income tax, and—most importantly—which one can save you the most money.

• Learn the key differences between credits and deductions
• Discover how each reduces your tax bill
• See real-world examples that show the impact on your refund or taxes owed
• Tips on how to maximize your tax savings

Whether you’re a small business owner, freelancer, or an employee looking to file smarter, this video will help you make sense of your tax return and find ways to keep more money in your pocket.

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TRANSCRIPTION

Tax Credits vs Tax Deductions: What’s the Difference & Which Saves More Tax

Tax credits versus tax deductions. What’s the difference and how can they help me? Grab a cup of coffee or a snack or both and come back to find out. Welcome everyone, today we’re tackling a topic that can save you money as soon as this tax season.

Tax credits versus tax deductions. What’s the difference and how can they help you keep more of your hard-earned cash? Let’s break it down. First off, when you file your taxes, nobody pays taxes on all of the income we earn.

There are deductions and a specific one called the standard deduction that’s automatically applied based on your marital status. That is, if you fell single, married, head of household, widower, etc. And this deduction reduces the amount one earns in order to reduce how much tax you end up paying.

Based on the taxpayer situation that year, they may qualify for other deductions and credits that can help even more. First off, let’s talk about tax deductions. A tax deduction lowers the amount of income you’re taxed on.

Think of it as a way to shrink your taxable income before the government calculates how much tax you owe. The lower your taxable income, the lower your tax bill. So let’s look at this scenario.

 
Candace is a single filer with a gross income of $60,000 for the year. She has a student loan interest deduction of $2,500 and also contributes $3,000 to a traditional IRA, both of which are deductible expenses. So step number one is going to be to calculate her adjusted gross income or her AGI.

Candace’s deductions reduce her taxable income as follows. $60,000 was her gross income. We’re going to subtract the student loan interest deduction of $2,500 and we’re going to subtract the $3,000 IRA contribution.

That’s going to reduce her income to $54,500. Step two, apply the standard deduction for 2024 tax year. As a single filer, Candace claims the standard deduction of $14,600.

She does this instead of itemizing this year. So we’re going to take the $54,500 and reduce it by her standard deduction of $14,600 and that’s taxable income of $39,900. Now on that, we calculate the tax liability.

So Candace’s taxable income falls within the 12% tax bracket after covering the 10% first bracket. Remember that our tax system is in steps or it’s a graduated tax system.

So the first $11,600 is taxed at 10%. That’s going to give you $1,160. The remaining $28,300 is taxed at 12% and that gives you $3,396.

Combine those two totals and that’s going to give you the total tax due of $4,556. What did the deductions do exactly? If Candace didn’t have her $5,500 in deductions, which is her student loan interest and her IRA contribution, her taxable income would have been $45,400 leading to a higher tax bill. So let’s take a look at the numbers.

The taxable income with the deduction was $39,900 and that left a tax liability of $4,556. Without the deductions, her taxable income was $45,400 and her tax liability was $5,216. So Candace saved $660 in taxes thanks to the deductions.

And you’re going to notice it’s not dollar for dollar. She spent a lot more in the tax interest, the student loan interest, and she spent a lot more in the contribution. It doesn’t translate to a dollar for dollar reduction, but it did save her $660.

Some of the more common deductions you’re going to see is the student loan interest deduction, mortgage interest, medical expenses, contributions to your retirement accounts, or charities. The more deductions you have, the less taxable income you’re going to have to report. But deductions don’t provide a dollar for dollar reduction in taxes like I said before.

Instead, they just lower the amount of income that is subject to the tax. So let’s take a look at tax credits. Now, tax credits are even more powerful.

A tax credit directly reduces the amount of tax that you’re going to owe. So if you owe $1,000 in taxes and you get a $500 credit, your tax bill drops to $500. It’s like a discount on your taxes.

There are two main types of credits. There’s the refundable kind and the non-refundable kind. Refundable credits can reduce your tax liability to zero and even result in a refund.

So for example, if you have a $300 tax liability and you have a credit of $1,000, then that $1,000 credit, $300 is going to go to eliminate your $300 tax debt. And then the $700 that remains is refunded to you, which is amazing, of course. However, the non-refundable credits can lower or eliminate your tax bill, but it won’t give you back any extra money.

 
Let’s take a look at it in this example. So Sammy is a single filer with a gross income of $50,000 for the year. He claims the standard deduction of $14,600, which is the amount for 2024, and qualifies for a $2,500 American Opportunity Tax Credit for education expenses.

Step one, let’s calculate the taxable income. So Sammy’s taxable income is determined as follows. Gross income is $50,000 and you’re going to subtract the standard deduction of $14,600.

That’s going to leave a taxable income of $35,400. On that, we calculate the tax liability. So based on 2024 tax brackets for single filers, the first $11,600 is taxed at 10%. That gives you $1,160. The remaining $23,800 is taxed at a 12% bracket, and that gives you $2,856. So you add those two and you have a total tax liability of $4,016.

Step number three, let’s apply the credit. So Sammy qualifies for the American Opportunity Tax Credit of $2,500. Since tax credits directly reduce the tax owed dollar for dollar, we apply it to his tax bill. So before the credit, he owed $4,016. We’re going to apply the $2,500 credit and he ends up owing $1,516. So what did the tax credit do? Without this tax credit, Sammy would have owed $4,016 in taxes.

With the $2,500 credit, his final tax bill drops to $1,516. That’s a straight up $2,500 reduction in tax liability. Much more powerful than a deduction, which only reduces your taxable income.

Let’s check out some of the more common tax credits. That would be the Child Tax Credit, Earned Income Tax Credit, the American Opportunity Credit, that’s for educational expenses. You have the Savers Credit for retirement accounts contributions.

You have the Energy Efficient Home Improvement Credits, and those are just a few of the more popular ones. In the examples that you just saw, you saw either the person getting a credit or a deduction, but many times taxpayers get both the deduction and the credits. So let’s see an example of how this would play out.

 
Let’s take a look at Emma’s tax return. Emma is a single filer with a gross income of $50,000. She qualifies for a deduction of $3,000 for student loan interest, and she qualifies for a credit of $2,000 for Energy Efficient Home Improvement.

She claims the standard deduction of $14,600 for 2024. So step one, let’s calculate the taxable income. We’re going to take a look at the gross income of $50,000.

We’re going to subtract the student loan interest of $3,000, and that’s going to leave her with an AGI of $47,000. Now we’ll subtract the standard deduction of $14,600, and her taxable income is now reduced to $32,400. Now on this number, we calculate the tax liability.

We said the first $11,600 is taxed at 10%, that’s going to give you $1,160. The remaining $20,800 is taxed at 12%, which is $2,496. And if you add them both up, you get a total tax liability of $3,656.

Now we apply the credit. Emma qualifies for the $2,000 Energy Efficient Home Improvement tax credit. Since tax credits directly reduce the tax owed dollar for dollar, we subtract it again.

So the tax before the credit was $3,656, we subtract the $2,000, and now she owes only $1,656. It’s important to realize that sometimes just because you qualify for credits and deductions one year, it doesn’t guarantee you’ll qualify the next because credits and deductions have phase outs or limitations. For example, the child tax credit ends when your kids turn 17.

So the child tax credit also has an income limitation and phases in and out depending on how low or how high your income is. The earned income credit also phases in and out based on how low or how high your income is. This is the credit that you’re going to see on those signs that are everywhere when you drive around advertising a very high refund amount based on the number of children that you have.

That’s assuming that you are in the exact amount of money that would yield the highest possible credit. And if you don’t, many of these tax preparation places are willing to force you to be by doing some unethical and even fraudulent things. So please be careful.

Education credits are refundable credits for the first two years, but afterwards they turn into non-refundable credits. It is also limited and may completely phase out for high income earners, so on and so forth. So here are some quick tips to make sure you’re getting the most tax benefits.

Keep track of all deductible expenses throughout the year. Consult a tax professional to ensure you claim all eligible credits. Use tax software to find credits and deductions that you might otherwise miss.

Contribute to your retirement accounts to lower your taxable income and if possible, time medical expenses and charitable donations to maximize deductions. And that’s it. That’s coupon tax credits versus tax deductions.

They both lower your tax bill, but they work in different ways. The key is understanding what you qualify for and using them to your advantage. If you found this to be helpful, be sure to like and subscribe and share.

And thanks for watching and have a happy tax season. 

SUMMARIZATION

When tax season rolls around, understanding how tax credits and tax deductions work can make a big difference in how much you owe — or how much you get back. Though both reduce your tax burden, they work in very different ways, and knowing how to use both can save you hundreds, even thousands.

What Are Tax Deductions?

Tax deductions reduce the amount of income that’s subject to taxation. Instead of paying taxes on every dollar you earn, deductions help shrink your taxable income, which lowers your overall tax bill.

Let’s take Candace as an example. She’s a single filer earning $60,000. She deducts $2,500 in student loan interest and $3,000 in IRA contributions. After subtracting those from her income, and then applying the standard deduction for 2024 ($14,600), she’s left with a taxable income of $39,900. This saves her $660 in taxes compared to if she hadn’t claimed those deductions.

But here’s the catch: deductions do not reduce your taxes dollar-for-dollar — they simply reduce the amount of income you’re taxed on.

What Are Tax Credits?

Tax credits, on the other hand, are more powerful because they reduce your tax liability directly, dollar-for-dollar. So if you owe $4,000 in taxes and qualify for a $2,000 credit, your new tax bill is $2,000.

Credits come in two types:

• Refundable credits — if they reduce your tax liability below zero, you get the difference back as a refund.
• Non-refundable credits — these can reduce your tax to zero, but you don’t get any excess refunded.

Take Sammy, who earns $50,000 and qualifies for the American Opportunity Credit ($2,500). After the standard deduction, he owes $4,016 in taxes. The $2,500 credit drops that to just $1,516 — a true dollar-for-dollar savings.

Combining Deductions and Credits

Most taxpayers qualify for both. Emma, for instance, earns $50,000, claims a $3,000 student loan interest deduction, and gets a $2,000 tax credit for energy-efficient home improvements. After applying deductions and the standard deduction, her tax bill drops to $3,656. Then the $2,000 credit reduces it further to $1,656.

Common Deductions and Credits

Common deductions include:

• Student loan interest
• Mortgage interest
• Medical expenses
• Charitable donations
• Retirement contributions

Popular tax credits include:

• Child Tax Credit
• Earned Income Credit
• American Opportunity Credit
• Saver’s Credit
• Energy Efficiency Credits

Be Aware of Limitations

Not all deductions or credits apply every year. Many have income phase-outs, age limits, or are only partially refundable. For instance:

• The Child Tax Credit ends when your child turns 17.
• The Earned Income Credit phases out if you earn too much or too little.
• Education credits start as refundable, then shift to non-refundable after two years.

Also, beware of shady tax preparers who promise big refunds by manipulating income or dependents. These practices are not only unethical, they can get you in legal trouble.

Final Thoughts

Tax credits and tax deductions both reduce what you owe, but credits usually save you more money. Deductions reduce your taxable income, while credits reduce your tax bill directly.

To make the most of your situation:

• Track expenses all year
• Contribute to retirement plans
• Consult a tax pro
• Use software or checklists to catch all you qualify for

Understanding the difference — and how to use both — is key to keeping more of your hard-earned money.