Tax Credits or Tax Deductions: Which Will Save You More?

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Although paying taxes is a fact of life, the IRS offers taxpayers the ability to reduce what they owe via various tax credits and tax deductions. But it’s not as simple as it sounds. Before you can qualify for each deduction or credit, you must meet specific criteria. And even though both deductions and credits can lower taxes, the way that they affect your overall tax bill and potential tax refund can be very different.

Here’s what you need to know about the differences between tax deductions and tax credits and how they can help you reduce your tax bill and maximize your tax refund.

Tax Credit vs. Tax Deduction — What It Means for Your Tax Refund

The primary difference between a tax credit versus a tax deduction is that a credit reduces the amount of tax you owe, and a deduction reduces your taxable income.

How a Tax Credit Affects Your Refund

The value of a tax credit is easy to measure because each dollar of credit reduces your tax liability by one dollar. For example, if your tax liability for the year is $10,000 but you have a $2,000 tax credit, your tax liability drops to $8,000. If your liability was $2,000, the $2,000 credit would reduce it to $0.

What that means for your refund depends on how much tax you paid during the tax year. Had you paid the entire $10,000 tax liability through tax withholding from your paycheck, you’d receive a $2,000 refund. If, on the other hand, you’d only had $8,000 withheld, you wouldn’t owe any additional tax, but you wouldn’t get a refund because you’d have paid the amount you owed after applying the credit.

How a Tax Deduction Affects Your Refund

How a tax deduction affects your refund depends on your tax bracket because a tax deduction only reduces your taxable income.

Tax brackets are the seven layers of income to which a particular tax rate applies. For 2024, the tax brackets are:

Your tax bracket is the one that applies to the last dollar you earned. So, if you had $40,000 in income, you’d be in the 12% tax bracket — your first $11,600 would be taxed at 10%, and your income from $11,601 to $40,000 would be taxed at 12%.

The tax rate for your last dollar earned — 12% in this example — is your marginal tax rate. The higher your marginal tax rate, the bigger your potential refund.

To find out how much a deduction saves you, multiply your marginal tax rate by the amount of the deduction. For example, if you can deduct $7,000 for the contributions you made to a traditional IRA and you fall in the 12% tax bracket, multiply $7,000 by 0.12 to find that the deduction saves you $840 on your taxes. If you were in the 32% tax bracket that tax year, that same $7,000 deduction would save you $2,240.

Learn More: 10 Tax Loopholes That Could Save You Thousands

What Are Tax Deductions?

Tax deductions are write-offs that you use to reduce your taxable income before you calculate how much tax you owe. For example, if you make $55,000, but you qualify for a $1,000 tax deduction, your taxable income drops to $54,000.

Deductions the IRS allows include adjustments to income and a choice between the standard deduction and itemized deductions.

Adjustments to Income

You can claim adjustments to income — sometimes referred to as “above-the-line” deductions — regardless of whether you claim the standard deduction or itemize your deductions. Adjustments to income include:

• Student loan interest
• Traditional IRA contributions
• Educator expenses
• Contributions to health savings accounts

Standard Deduction vs. Itemized Deductions

The standard deduction makes it easier to do your taxes because it’s a flat amount — $14,600 for individual filers ($29,200 for married joint filers) — no worksheets, schedules or calculations needed on your part. But some taxpayers get a bigger break by itemizing deductions.

Itemized deductions are individual expenses the IRS lets you deduct from your taxable income. Some of the more common ones are:

• Charitable donations
• Gambling losses, up to the amount of your winnings
• Medical expenses that exceed 7.5% of your adjusted gross income
• Mortgage interest
• Property tax, up to certain limits

Each year, you have to decide whether to itemize your deductions or take the standard deduction.

Learn More: Tax Write-Offs You Don’t Know About

What Is a Tax Credit?

A tax credit is an amount that is subtracted directly from the amount of tax that you owe. For example, if you owe $4,000 in taxes and qualify for a $1,000 tax credit, you will only owe $3,000 in taxes.

Tax credits fall into three categories: refundable credits, partially refundable credits and nonrefundable credits.

Refundable Credits

Refundable credits allow for a full refund if the credit reduces your tax liability to less than $0. For example, say your total tax liability for the year is $1,500. If you have a $2,000 refundable tax credit, you’ll get a $500 refund. If your tax liability is $0, you’ll get the full $2,000 as a refund.

Examples of refundable tax credits include:

• Earned income tax credit
• Premium tax credit
• Additional child tax credit

Partially Refundable Credits

A partially refundable credit allows a portion of the credit to reduce your tax liability to less than $0 so that it can be refunded to you even if you don’t owe tax. The child tax credit is a good example. While technically two credits, one that’s refundable and one that’s not, the IRS considers it a partially refundable credit.

The nonrefundable child tax credit is worth $2,000 per eligible child in 2024. If you can’t claim the entire thing, you can claim the “additional child tax credit” and have up to $1,700 of your $2,000 credit refunded to you.

So, if you qualify for the $2,000 child tax credit and your tax liability is $4,000, the credit will reduce your tax liability to $2,000. If your tax liability is $0, the additional child tax credit kicks in to reduce your taxable income to -$1,700, effectively refunding all but $300 of the child tax credit.

Nonrefundable Credits

Nonrefundable credits can only be used to reduce your income taxes to $0. Once your total taxes for the year get to $0, nonrefundable credits can’t increase your refund further. So, if you owe $4,000 in taxes but have $5,000 in credits, the credits reduce your tax liability to $0.

Popular nonrefundable tax credits include:

• Child and dependent care credit
• Lifetime learning credit
• Credit for other dependents
• Savers credit
• Energy efficient home improvement credit

Who Benefits Most From Tax Credits and Tax Deductions?

When examining the benefits of tax deductions vs. tax credits, tax credits provide the most benefit to lower- and middle-income taxpayers. The reasons are that many credits have income limits, and lower income means lower tax liability or even no tax liability. Refundable and partially refundable credits like the earned income and child tax credits provide refunds for these taxpayers even if they haven’t paid or overpaid tax.

Tax deductions, on the other hand, benefit higher income taxpayers by reducing taxable income. If deductions reduce taxable income enough, they could bump the taxpayer into a lower tax bracket. In that case, the taxpayer reaps additional savings by paying a lower tax rate on their already-reduced taxable income.

Upcoming Tax Changes To Watch For

Every year, the IRS makes changes that can affect your tax liability. Here are some of the changes the IRS has announced so far for 2025:

• The standard deduction will increase by $400 to $800, depending on your filing status.
• Tax brackets remain the same, but marginal tax rates within each bracket apply to higher income amounts, which could reduce taxes for some taxpayers and keep others from landing in higher tax brackets.
• The earned income tax credit increases by $216.
• Exemptions for the alternative minimum tax increase, which helps more taxpayers to avoid it.

Strategies for Maximizing Your Tax Credits and Deductions

Taxes are inevitable for most Americans, but you can ease their burden by taking steps to maximize credits and deductions.

• Research tax deductions and credits so you’ll know what you’re entitled to claim. The IRS website, located here, is an excellent resource.
• Keep accurate financial records, and organize deductible and credit-eligible expenses by category. At the end of the year, total them to them so you’ll know whether to take the standard deduction or itemize your deductions.
• If you’re married, calculate your tax liability as separate filers and joint filers both to see which is most beneficial.
• Contribute the full allowable amount to your tax-deferred retirement accounts and flexible or health savings account
• Schedule potentially deductible end-of-the-year spending such as mortgage payments (for mortgage interest), medical expenses, business expenses and charitable contributions for when they’ll benefit you most — at the end of this year or the beginning of next year.

Takeaway

Finding and working with a financial advisor is a great idea. A financial advisor will help keep track of your finances and assist you in attaining your financial goals. While finding the right one can be overwhelming, you can decide to work with a financial advisor in your community or a virtual one.

Get to know your financial advisor options today for free!

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Josephine Nesbit and Daria Uhlig contributed to the reporting for this article.

Last updated: Jan. 1, 2025.

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