The silver lining of filing a tax return is the potential promise of a refund.
So whats the difference between a tax credit and a tax deduction and which is better?
It is a direct reduction in your total tax bill.
Not sure what tax bracket you fall into? Our guide explains thetax brackets for 2022.
Tax deductionsreduce the total amount of your income that is subject to taxation.
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If you have multiple children, you will receive a tax credit for each of them.
This year, the entire credit is refundable (more on that next).
Instead, both you and Uncle Sam will walk away empty-handed.
Luckily, some tax creditsarerefundable.
As mentioned above, the Child Tax Credit is refundable, as is the Earned Income Tax Credit.
For these, youcanget a refund look to see if your credit outweighs what you owe.
But you’re able to also reduce what you owe with a deduction.
Tax deductions are likely what you are more familiar with.
No matter your financial situation, you are free to claim this standard deduction that applies to everyone.
Standard Deductions at a Glance
Not sure of your filing status?
The IRS offersa useful toolto figure it out; it takes roughly 5 minutes to complete.
Take the standard deduction instead.
Review our example scenarios to see how each reduces what you owe.
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Tax Credit Scenario
Congratulations.
Youve qualified for a tax credit of $5,000.
That takes $5,000 off your total tax bill.
Youve qualified for a tax deduction of $5,000.
That reduces your AGI to $70,000.
At the 22% tax rate on $70,000, you owe the government $15,400.
As you could see, tax credits can save you more on your tax bill.
And remember, nonrefundable tax credits cant earn you any money; theyll just reduce what you owe.
If researching potential credits and deductions and determining eligibility sound too complicated, consider a professional tax preparer.
Timothy Moore covers bank and investment accounts for The Penny Hoarder from his home base in Cincinnati.
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