A tax credit reduces the actual amount of tax you owe, dollar for dollar.
Unlike deductions, which lower the income you’re taxed on, credits lower your tax bill directly.
Types of Tax Credits
Nonrefundable Credits
- Can reduce your tax bill down to $0
- No refund if the credit is more than the tax you owe
Example: Saver’s Credit
Refundable Credits
- Can reduce your tax below $0
- May result in a refund even if you owe no tax
Example: Earned Income Tax Credit (EITC)
Partially Refundable Credits
- One part reduces your tax
- The remaining portion may be refunded to you
Example: American Opportunity Credit
Example
You owe $1,500 in federal tax.
- You qualify for a $1,000 tax credit
- Your new tax bill is $500
If the credit is refundable and you owe $0 in tax, you could receive up to a $1,000 refund. However, if the credit is non-refundable, it will not impact your refund amount.
Credits vs. Deductions: What’s the Difference?
Tax Credit
- Lowers your tax bill directly
- Saves you the full dollar amount of the credit
- Some credits are refundable
Tax Deduction
- Lowers your taxable income
- Savings depend on your tax bracket
- Deductions are never refundable
Quick Example
A taxpayer owes $2,000 in taxes:
- With a $1,000 tax credit → tax owed becomes $1,000
- With a $1,000 tax deduction → taxable income drops by $1,000
- If in the 22% tax bracket, tax savings = $220
Summary
- Credits are more valuable because they lower the tax you owe dollar‑for‑dollar
- Deductions lower income, which may reduce tax by a smaller amount