A tax credit and a tax deduction are both methods used to decrease the amount of taxes owed to the government, however, they differ in how they achieve this end result.
A tax credit reduces the amount of tax owed by a certain dollar amount, regardless of the taxpayer's income or tax bracket. For example, if a taxpayer owes $10,000 in taxes and has a $2,500 tax credit, the taxpayer only owes $7,500 in taxes.
On the other hand, a tax deduction is a reduction in the amount of income that is subject to tax. Taxpayers can deduct certain expenses from their taxable income, such as charitable donations or mortgage interest. This reduces their taxable income, which results in a lower tax bill. However, tax deductions are based on the taxpayer's tax bracket, and are only worth as much as the taxpayer's marginal tax rate. For example, if a taxpayer in the 24% tax bracket has a $2,500 tax deduction, their tax bill is reduced by $600 (24% of $2,500).
It is important to note that both tax credits and tax deductions have limitations and exceptions. Tax credits may have income limits or restrictions on how much of the credit can be claimed. Additionally, some tax credits are only available for a limited time. Tax deductions may be limited by a taxpayer's income, the type of expense being deducted, or the amount of the expense incurred.
If a taxpayer wants to take advantage of tax credits or deductions, it is important to consult with a licensed tax professional or accountant to ensure that they are eligible and to determine the best strategy for their specific situation.
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