---
title: "Tax Credit vs Tax Deduction: Understanding the Difference"
description: Learn about the differences between tax credits and tax deductions and how to use them to reduce the amount of tax you are required to pay.
image: https://blog.cmp.cpa/hubfs/Tax%20Credit%20vs%20Tax%20Deduction%20Understanding%20the%20Difference%20-%201.jpg
---
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# Tax Credit vs Tax Deduction: Understanding the Difference
Published December 16, 2021 By [John Kane](https://blog.cmp.cpa/author/john-kane)
Tax Credit vs Tax Deduction: Understanding the Difference
15:32
People who want to save money on their taxes can do so with a combination of tax credits and tax deductions. Used in combination, credits, and deductions can reduce your taxable income and your tax liability.
At [CMP, a nationwide CPA firm based in Utah,](https://cmp.cpa), we work with taxpayers every day to help them prepare their tax returns and save money where they can. One of the questions we hear a lot is this:
## What is the difference between a tax credit and a tax deduction?
We love answering this question because it highlights a common misunderstanding. People sometimes use the terms **tax credit and tax deduction** interchangeably, but they differ.
## What is a Tax Credit?
Let's start with tax credits. Simply stated, a tax credit is a specified amount that can be subtracted directly from the tax you owe. Credits are tied to qualifications laid out in the tax code, and only those who meet them can claim them.
Unlock the secrets of a fairer taxation system! Discover the fundamental principles behind a progressive tax code and its intricate workings. Unravel the complexities of this economic concept that affects us all, regardless of our background or occupation. Explore our blog post, "The Basics of a Progressive Tax Code: What It Is and How It Works," which breaks down the basics of a progressive tax code and sheds light on how it functions to create a more equitable society. Don't miss out on this opportunity to deepen your understanding of an essential component of our economic system.
Examples of tax credits you may have heard about include the following.
- The Earned Income Tax Credit (EITC)
- [The Saver's tax credit](https://blog.cmp.cpa/savers-tax-credit)
- The Child and Dependent Care tax credit
- [The American Opportunity tax credit](https://www.irs.gov/credits-deductions/individuals/aotc)
- The Lifetime Learning tax credit
The American Opportunity Tax Credit helps eligible taxpayers pay for the first four years of postsecondary education. The Saver’s Credit helps eligible taxpayers who contribute to qualifying retirement accounts.
We will go into detail later about the different types of tax credits and how they work, but for now, you should know that credits are available to many taxpayers and if you qualify, you should take any credits you are entitled to take when you file your tax return.
## How Do Tax Credits Work?
Now, let's review how tax credits work. As we noted above, any tax credit you take is subtracted directly from the amount of taxes you owe, giving you a dollar-for-dollar reduction on your tax bill. Let's look at an example.
Without any tax credits, Dan realizes that he owes $10,000 in taxes. His accountant tells him that, because he is paying for his daughter's college education, he is eligible for the American Opportunity Tax Credit. This is a credit that reimburses taxpayers for up to $2,500 in eligible expenses associated with their first four years of post-secondary education.
With the American Opportunity Tax Credit, Dan can subtract $2,500 from his $10,000 tax bill, lowering it to $7,500. We should note here that the $2,500 credit is per student, so if Dan had two children in college, he could claim $5,000 in credits.
It is important to note that tax credits do not change your income tax bracket because they do not reduce your taxable income. Instead, they serve as direct savings after you have calculated what you owe.
Check out our latest blog post on [how the Big Beautiful Bill changes R&D tax credits](https://blog.cmp.cpa/one-big-beautiful-bill) to understand what these new updates mean for businesses looking to claim research incentives effectively.
### Types of Tax Credits
While there are many different tax credits you may be eligible to take, they all fall into three basic categories based on whether you can get the credit as a refund if only partial credit is required to reduce your tax bill to zero.
### Nonrefundable Tax Credits
A nonrefundable tax credit is exactly what it sounds like: a tax credit that may not be refunded under any circumstances. If you owed one dollar on your taxes and were eligible for a $1,000 credit, you could only use $1 of the credit. The remaining $999 could not be refunded to you.
An example of a nonrefundable tax credit is the Saver's Credit, which is for taxpayers who contribute to eligible retirement savings plans.
### Refundable Tax Credits
A refundable tax credit, as you may have guessed, is a credit that is fully refundable when not used in its entirety. If you were due multiple credits and you could reduce your tax liability to zero without using all of a refundable tax credit, you would receive the balance as a refund from the Internal Revenue Service.
An example of a refundable credit is the EITC, which is in place to offset regressivity in the tax code that adversely impacts low-income individuals and families. Someone eligible for the EITC may receive the balance of the credit as a refund.
### Partially Refundable Tax Credits
A partially refundable tax credit is one where some, but not all, of the credit, is refundable. An example is the American Opportunity Tax Credit, which we have mentioned.
For eligible taxpayers, 40% of the allowable American Opportunity Tax Credit is refundable, up to $1,000 per eligible student. The remaining 60% is nonrefundable and can reduce income tax liability to zero. Some taxpayers, including certain students under age 24, do not qualify for the refundable portion.
## How Are Tax Credits Calculated?
Tax credits are calculated on a case-by-case basis. For any tax credit available, the IRS has a publication that explains how the credit works and how to determine your eligibility.
Let's use the American Opportunity Tax Credit as an example. According to the[IRS website](https://www.irs.gov/credits-deductions/individuals/aotc), students will receive Form 1098-T from their schools by January 31. This form is part of the process of determining your eligibility. You will also need to look at[IRS Publication 970](https://www.irs.gov/pub/irs-pdf/p970.pdf) to figure out how much to claim.
## What is a Tax Deduction?
A tax deduction is something that reduces the amount of your taxable income and can potentially save you money by dropping you into a lower tax bracket. Like tax credits, tax deductions are part of the tax code, and you must meet the qualifications to take the deduction. The primary difference between tax credits and tax deductions is that credits directly reduce the amount you owe, and deductions reduce your taxable income.
Here are some examples of tax deductions:
- State & local income tax paid deduction
- [Charitable contribution deduction](https://blog.cmp.cpa/claim-charitable-contributions)
- [Property tax deduction](https://blog.cmp.cpa/second-home-tax-deductions)
- Mortgage interest deduction
The charitable contribution deduction allows taxpayers to deduct some of the donations they make to charity to [reduce their taxable income](https://blog.cmp.cpa/reduce-taxable-income-high-earners), while the mortgage interest deduction is something homeowners can do to save money on their taxes.
## How Do Tax Deductions Work?
Tax deductions reduce the income used to calculate your taxes. Above-the-line deductions reduce adjusted gross income (AGI). The standard deduction and itemized deductions generally reduce taxable income after AGI has been calculated.
For a hypothetical 2026 example, assume Melanie is single, under age 65, not blind, and has $170,000 in wages with no other income or adjustments. Her AGI is $170,000. After subtracting the $16,100 standard deduction, her taxable income is $153,900.
Using the 2026 ordinary income tax brackets, her federal income tax before credits and other taxes is $29,534. Her marginal tax rate is 24%. The standard deduction reduces her taxable income but does not change her AGI.
If Melanie itemizes deductions, she could save even more than in our example. We will discuss that in the next section.
[](https://hubspot-cta-redirect-na2-prod.s3.amazonaws.com/cta/redirect/1853761/7a126bcb-21fb-48d5-9466-7632d4be448c)
## Types of Tax Deductions
There are four types of tax deductions you should know about.
### Standard Deduction
Eligible taxpayers can claim the standard deduction instead of itemizing. For tax year 2026, the basic standard deduction is:
- Single or married filing separately: $16,100
- Married filing jointly or qualifying surviving spouse: $32,200
- Head of household: $24,150
Different amounts can apply to dependents, and additional standard deductions may apply for age or blindness.
Are you and your spouse unsure about how to file your taxes this year? Discover the pros and cons of [Married Filing Jointly vs Separately](https://blog.cmp.cpa/married-filing-jointly-vs-separately). We break down the differences and help you understand which option might better fit your unique financial situation.
If you cannot save money by itemizing your deductions, you should take the standard deduction.
### Itemized Deductions
There are certain circumstances in which you may not use the standard deduction and circumstances when it is not desirable.
According to the IRS, people in the following categories may not take the standard deduction and must itemize.
- A person who is married filing separately whose spouse itemizes deductions.
- A person filing a tax return for a period that is less than 12 months due to a change in their annual accounting period.
- Generally, nonresident or dual-status aliens, subject to exceptions. Exceptions include certain taxpayers who elect resident treatment with a spouse and certain Indian students and business apprentices eligible under the U.S.-India income tax treaty.
- An estate, partnership, or common trust fund.
If you have itemized deductions that total more than the standard deduction, then itemizing is advantageous. People who itemize deductions must use Form 1040. We explain the details of how to claim tax deductions later in this post.
## Above-the-Line Tax Deductions
An above-the-line tax deduction is subtracted from your gross income to calculate your Adjusted Gross Income.
Examples include eligible personal HSA contributions and qualifying alimony payments under certain divorce or separation agreements executed before 2019.
## Below the Line Tax Deductions
A below-the-line tax deduction is an amount that is deducted below the point where you have calculated your Adjusted Gross Income. In most cases, above-the-line deductions save taxpayers more money than below-the-line deductions.
Examples of below-the-line deductions include charitable donations and qualified medical expenses.
## How to Calculate Tax Deductions
Now, let's talk about how to calculate deductions. The United States tax code is complex and can be difficult to understand. If you want to itemize deductions, you may want to work with a certified tax professional to determine which itemized deductions you can take.
As with tax credits, the rules for calculating tax deductions can be confusing. Let's look at the Health Savings Account deduction as an example.[IRS Publication 969](https://www.irs.gov/publications/p969) explains HSA contribution and deduction rules. Report contributions on Form 8889. Employer contributions, including employee contributions through a cafeteria plan, appear in Form W-2, box 12, code W. Direct personal contributions generally do not appear on your W-2. Contributions already excluded from income generally cannot also be claimed as an HSA deduction.
Deductions are reported in different places on your return. Some appear directly on Form 1040, while others are calculated on schedules or supporting forms.
## Itemizing vs the Standard Deduction: Which Should I Choose?
When deciding between the standard deduction and itemized deductions, you first need to consider whether you qualify to take the standard deduction. We listed the categories that disqualify you from the standard deduction above. For example, if you are married filing separately and your spouse is itemizing deductions, you must also itemize.
If you qualify for the standard deduction, compare it with your allowable itemized deductions. Itemizing generally makes sense when it produces a lower overall tax liability.
The best way to determine if you should itemize is to calculate your tax deductions individually and total them. You should itemize if the total amount you can deduct is higher than your standard deduction. Remember that qualified expenses related to your work may be deductible.
Keep in mind that itemizing deductions does not preclude you from taking tax credits for which you are eligible. However, the [Tax Cuts and Jobs Act of 2017](https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-a-comparison-for-businesses) nearly doubled the standard deduction, and the result is that fewer people can save by itemizing.
Filing and paying business taxes properly is crucial for small business owners. If you’re just launching a new business, you might wonder: How much are business taxes in Utah? Our guide will help you navigate your tax obligations and ensure compliance. For a detailed understanding, read our article: [A 2024 Employer's Guide to Small Business Taxes in Utah.](https://blog.cmp.cpa/small-business-taxes-utah)
## How to Claim Tax Deductions and Tax Credits
The process of claiming tax deductions and tax credits is complex. Some of the most common tax credits have a line on Form 1040. Here are the credits you can find there:
- Earned Income Credit - Line 27
- Additional [Child Tax Credit](https://blog.cmp.cpa/child-tax-credit) - Line 28
- [American Opportunity Credit](https://blog.cmp.cpa/save-for-college-education) - Line 29
Follow the instructions for the applicable tax year. Claim the American Opportunity Tax Credit using Form 8863. If you claim EITC with a qualifying child, attach Schedule EIC to provide information about that child. Schedule EIC is not required when claiming EITC without a qualifying child.
Claim the standard deduction or report your total itemized deductions on the designated line of Form 1040 or 1040-SR. Use Schedule A to calculate itemized deductions. Check the current form instructions because line numbers and page locations can change.
## Our Tax Pros Can Help Minimize Your Tax Bill
We recognize that the process of determining your eligibility for tax credits and tax deductions may be arduous and confusing. For that reason, it is recommended that you work with a qualified tax professional if you have questions about a deductible expense or credit.
Do you need help with your [income tax preparation](https://cmp.cpa/services/income-tax-services/) or minimizing tax payments? Our CMP tax pros are here to help.
[](https://blog.cmp.cpa/hs/cta/wi/redirect?encryptedPayload=AVxigLJiJkTrpK4KabY3vHl92LRdXa8a%2Fab8V9qB4k2NCz6%2Bqq5tVPaHxVlal4wgXTL0IoBCb9awVLdPq%2BoF64jCpj2jyfcWgAz9yKuv5ikIeeRvtI8jw2ZsW%2FJcK1wXvA75xHft4MMaxandO%2Bh%2BTskEBboSadrxfSx2rzKRr4bz90pvOivl0ao%2FJbPVsdbkzQpoa7YcsRgtblhCIL53&webInteractiveContentId=213589506690&portalId=1853761)
*This content is for educational purposes only and may not apply to your specific tax situation. Tax laws are complex, subject to change, and depend on individual circumstances. Consult a qualified tax advisor before relying on this information.*
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About John Kane
John enjoys interacting with clients and proactively working with them to create solutions to problems. John is a native of Logan and earned both a bachelor’s and a master’s degree in accounting from Utah State University. He has been with CMP, PC, since 2012. John’s primary focus is on businesses in the medical, manufacturing, retail, construction, and agriculture industries. In addition, John has extensive experience in IRS issue resolution. Prior to joining CMP, John worked in Idaho Falls for a CPA firm where he gained experience in auditing governmental and nonprofit entities.
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