What is the difference between a tax deduction and a tax credit?

While both of these are helpful, they function very differently! A tax deduction reduces the amount of taxable income, while a tax credit directly reduces the amount of money you owe in taxes.

With a tax deduction, you are simply decreasing the amount of money you will pay taxes on. For example, if you made $50,000 per year. However, a standard tax deduction of $12,550 would take your taxable income down to $37,450, which may drop you into a lower tax bracket. As a result, you would only be taxed on that amount. You may use itemized deductions instead, but the effect is the same.

A tax credit, on the other hand, would simply subtract a certain amount from what you owe in taxes. So, if you get a tax credit of $1,000, you will pay the IRS $1,000 less. Some tax credits are refundable, while others are not.