Tax Credits vs Tax Deductions Differences
Tax Credits and Tax deductions can aid in reducing the overall income tax liability and is something which all tax-payers want to take advantage off. 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 computed using the percentage of marginal tax bracket.
Tax Credits vs Tax Deductions Infographics
Below infographics details the top 5 differences between tax credits vs tax deductions.
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. The major benefit of the tax credit is it directly reduces the component of tax liability and is directly measured in terms of respective currency. There are various types of tax credit available:
- Income Tax Credit: When an assessed is charged tax greater than their actual liabilities resulting from various factors, then the surplus amount is available as a tax credit which can be carried forward to the following financial year and adjusted against subsequent tax obligations. As an alternative, the amount may be paid and subsequently, the excess amount is credited back in the account of the taxpayer.
- Input Tax Credit: This is the credit available to registered dealers and manufacturers for the inputs they purchase for the purpose of reselling. Recently, the GST (Goods & Service Tax) passed by the Government of India, offers a tax credit to manufacturers who are paying GST of 18% of more. This way they are encouraged to continue their activities and keep the prices at existing levels or even lower them.
- Foreign Tax Credit:It is a non-refundable tax credit for income taxes paid to a foreign government resulting from income tax withholdings. The tax credit is available to anyone who either has investment income from a foreign source or is working in a foreign country. For e.g., if a portion of tax payer’s foreign income is taxable and some are exempt, the taxpayer must be able to only claim the credit for taxes paid on foreign income.
What is Tax Deduction?
These deductions are qualified expenses which can reduce the Gross taxable income (GTI) either by a specified amount or percentage. Provisions for the same are made by the tax authorities 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 makes an investment in 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.
Key Differences Between Tax Credits vs Tax Deductions
- A tax deduction is an eligible expense which reduces the table income of the assessee whereas tax credit is an incentive whereby taxpayers are able to reduce the amount of tax under given circumstances.
- Tax deduction is available to the assessee if a specific expense has been incurred whereas tax credit arises if any excess amount of tax has been deposited with the taxation authorities.
- A tax deduction saves the taxation liability by a small amount since the restriction is imposed on the maximum deduction whereas tax credit is adjusted by a larger and is computed on a dollar to dollar basis.
- Tax deduction reduces the taxable income of the assessee and a tax credit reduces the overall tax liability of the assessee.
Tax Credits vs Tax Deductions – Head to Head Differences
|Basis for Comparison between tax credits vs tax deductions||Tax Deduction||Tax Credit|
|Meaning||These are deductions which 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.|
|Benefits||Helps in reducing taxable income||It is an obligation in payment of taxes.|
|Point of adjustment||Adjusted before application of the tax rate.||Adjusted after the tax due is ascertained.|
|Tax Saving||It reduces tax by a marginal percentage||The tax reduction is applicable on a dollar to dollar basis.|
|Reason of existence||It is offered due to variety of expenses borne by the tax payer||This is due to tax already deposited with the tax authorities or specific circumstances.|
Tax Credits vs Tax Deductions – Final Thoughts
Though both these tax credits and tax deductions avenues help in reducing the tax burden for any tax payer, the advantages offered are different and one should accordingly take advantage of them. Tax deduction is offered to a large number of people and hence will have a minimal impact. 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.
This has been a guide to top differences between tax credits vs tax deductions. Here we take the differences between the two with examples, infographics, and comparative table. You may also have a look the following articles to learn more –