Tax Credits vs Tax Deductions

Difference Between Tax Credits and Deductions

Tax credit refers to the amount reduced directly from the total tax liability of the person or corporation, whereas, tax deductions are deductions that are allowed to be deducted from the total income of the person or corporation which thereby results in reduction of tax liability by decreasing  taxable income not by directly decreasing the tax liability amount.

Tax credits and deductions can aid in reducing the overall income tax liability and is something that all taxpayers want to take advantage of. Tax credits can help to reduce the liability at a dollar to dollar level but cannot reduce overall liability to less than zero. Tax deductions, on the other hand, lower the taxable income and are calculated using the percentage of marginal tax brackets.

Tax-Credits-vs-Tax-Deductions

You are free to use this image on your website, templates etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Tax Credits vs Tax Deductions (wallstreetmojo.com)

What is Tax Credit?

Tax Credit refers to the amount which can be offset against the overall tax obligation. It is the total amount which an assessee can reduce from the taxes payable to the authorities. Its major benefit is it directly reduces the component of tax liability and is directly measured in terms of the respective currency. There are various types of tax credit available:

What is a Tax Deduction?

Tax deductions are qualified expenses that can reduce the gross taxable income (GTI) either by a specified amount or percentage. The tax authorities make provisions for the same during the commencement of the financial year.

Assesses can claim deductions on various expenses such as:

  • Medical expenses for self and family
  • Life Insurance Premiums
  • Contribution to funds permitted by the Government
  • Donations to institutes permitted by the Government etc.;

For instance, as per the Indian Taxation law, if an assessee invests Section 80C, which encourages savings associated with Government, the taxpayer does not have to pay any tax on them, and it also reduces their overall taxable income. The limit here is INR 1, 50,000, which is eligible to be tax-free.

Tax Credit vs. Tax Deduction Infographics

Let’s see the top differences between tax credits vs. tax deductions.

TAX CREDIT VS TAX DEDUCTION

You are free to use this image on your website, templates etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Tax Credits vs Tax Deductions (wallstreetmojo.com)

Key Differences Between Tax Credits and Deductions

  1. A tax deduction is an eligible expense that reduces the table income of the assessee. In contrast, the tax credit is an incentive whereby taxpayers are able to reduce the amount of tax under given circumstances.
  2. A tax deduction is available to the assessee if a specific expense has been incurred. In contrast, tax credit arises if any excess amount of tax has been deposited with the taxation authorities.
  3. A tax deduction saves the taxation liability by a small amount since the restriction is imposed on the maximum deduction. In contrast, the tax credit is adjusted by a larger and is calculated on a dollar to dollar basis.
  4. A tax deduction reduces the taxable income of the assessee, and a tax credit reduces the overall tax liability of the assessee.

Comparative Table

Basis for ComparisonTax DeductionTax Credit
MeaningThese are deductions that help in reducing the overall taxable income applicable for tax.It is a tax incentive whereby the taxpayer is able to deduct the amount of tax under specific circumstances.
BenefitsHelps in reducing taxable incomeIt is an obligation to payment of taxes.
Point of adjustmentAdjusted before application of the tax rate;Adjusted after the tax due is ascertained.
Tax SavingIt reduces tax by a marginal percentage.The tax reduction is applicable on a dollar to dollar basis.
Reason of existenceIt is offered due to a variety of expenses borne by the taxpayerIt is due to tax already deposited with the tax authorities or specific circumstances.

Conclusion

Though both these avenues help in reducing the tax burden for any taxpayer, the advantages offered are different, and one should accordingly take advantage of them. A tax deduction is offered to a large number of people and hence will have a minimal impact. The tax credit, on the other hand, offers a precise amount of money for any excess tax paid retrospectively. Thus, the pros and cons should be ascertained accordingly.

Tax Credits vs. Deductions Video

Recommended Articles

This article has been a guide to tax credits vs. tax deductions. Here we discuss the top differences between them along with infographics and comparative table. You may also have a look at the following articles to learn more –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *